Are High Commodity prices here to stay?

Commodity and Energy prices have surged over the past 24 months with the Bloomberg commodity index, a broad basket of commodities including energy, metals, and food, appreciating over 100% since the COVID-19 trough in March 2020. If you exclude Energy, the index for other commodities is still up by over 90% over same period.  

If you compare charts for Oil prices and the major Mintec Food Commodity Indexes since January 2017, you can see that commodity prices were generally flat in the period to early 2020 with historically low volatility in the markets. With the impact of Covid in Quarter 1 2020 we saw the fall in Oil prices from the impacts of economies slowing and then from Quarter 2 Oil trending sharply higher and other commodities following in from Quarter3.  By early 2021 prices had moved out of long-term trading range and a strong Bull market was developing. After pausing at end of 2021, we saw a new leg of the Bull market in 2022 as risk and then impact form Ukraine war was priced into market.    

These commodity increases have now spread to wider economy as retailers pass on increases to customers. As a result, global inflation has increased to levels not seen in 40 years. This increase has been widespread: In February 2022, year-on-year headline inflation was 6.2% in the UK, 5.9% in the Eurozone and 7.9% in the US, and it is likely to peak in the 8%-9% range. 

The reasons why commodities have been impacted in this way can be tied back to the risks of COVID-19 which reduced the consumption of services, triggering a large increase in the consumption of goods. In graphic terms, people suddenly stopped going to the gym and bought a bicycle. This meant that the global supply of durable goods became insufficient overnight. The reopening of economies on depleted inventories caused a further sudden increase in the global demand for goods generating a sharp increase in the global demand for energy. Goods are more energy intensive to produce than services – think again about the comparison between going to the gym and buying a bicycle. This met an energy market that was undersupplied for a variety of reasons, including years of underinvestment in fossil fuels, not enough renewable energy capacity and a geopolitical risk premium. The Russian invasion of Ukraine has added to this supply shortage and risk premium. Because energy commodities are a critical input for metals and food commodities, the energy price surge had severe spill overs in the rest of the commodity market to a far greater extent than that attributable to supply and demand. 

So, what next?

Over past 2 years we have seen a series of Commodity price shocks after many years of benign commodity prices. Economists look to define Commodity price changes as either “Transitory” or “Permanent”.  

Transitory shocks can originate from recessions such as the 2009 global financial crisis, adverse weather conditions which are most common to agriculture e.g. frost in Brazil impact on coffee in 1985 and to an extent 2021. As their name defines, they are not a permanent disruption to the market and are corrected although that may take several years. 

Permanent changes often result from a key change to supply and demand, often changing technology or external factors driving changing costs of production. For example, changes in shale extraction technology in the natural gas and oil industries rendered the United States a net energy exporter in 2019, for the first time since 1952 and which is driving the huge divergence in energy costs in USA and Europe today.  

As we progress into remainder of 2022 and into 2023 and with most commodities at record levels today one of key inputs companies will be looking to their Procurement and Supply Chain teams is defining the which Commodity price shocks are Permanent and which are Transitory and what are the strategies you have in place to manage both.  

What does history tell us?

Not a lot really. According to a study by world bank analysing prices back to 1970’s, roughly 50% of Commodity shocks have been Permanent and 50% Transitory. Permanent shocks accounted for two-thirds of the variability in annual agricultural commodity prices, but less than half of the variability in base metals prices. For energy prices (Oil and Gas) Transitory shocks are main driver of price volatility.   

Some clues for future?

Energy price volatility has historically mainly resulted from Transitory shocks. However, one of most significant Permanent shock that has occurred in Energy was the new spare capacity that became available in the global oil and gas market following the collapse of the former Soviet Union. For Oil, a key question is – will we see a reversal of this following the sanctions imposed by many countries following the war in Ukraine?  History shows that irrespective of the political will of many countries’ commodities continue to find a route to market despite sanctions. So Russian Oil will continue to trade (perhaps at a discount) only to different markets than today. In addition, fossil fuel substitution and demand contraction driven by Western European need to reduce demand on Russian production and desire move to a more sustainable economy. Add in the prospects of reduced GDP growth due to reduced consumer spending due to decline in real incomes and this energy price shock could follow most recent events and be composed of a series of Transitory price shocks that could quickly unwind.   

Agricultural commodities are more complex. The scarcity of commodities is, by definition, a Transitory shock that recovers traditionally by supply increases driven by higher prices for producers. However, food commodities have been impacted by a far wider series of events. High input costs from energy (and as a result other costs such as fertilizer) may abate but other structural issues remain. Demand is generally constant and growing in line with population growth. Supply is adversely impacted by changing climate which is increasingly making commodity growing marginal and reducing yield in many traditional growing regions. Land and labour scarcity from growing urbanisation is a common theme. Also, in many economies the impact of generally low commodity prices for the last 5 years, high input costs (fertilizer) and current high commodity prices not reaching growers may result in agricultural crop supply failing to increase despite higher pricing. With the Russia / Ukraine war adding major disruptions in supply chains for some food commodities and with generally low stocks, it is realistic to expect future agricultural and food commodity prices to continue at significantly higher levels than those we came to expect prior to Covid.   

Impact for Procurement Teams

An analysis of the cost drivers quickly shows that it’s not just the cost of energy that’s driving inflation but that non energy commodities indexes have been trading at levels above historic levels for the past year.  

As we have discussed above, there is significant risk that pricing on many Agricultural / Food Commodities will stay high when viewed against historic levels pre-Covid.  

The challenge for procurement teams will be to continue driving the cost optimisation programs to recover companies’ margins but in a very different and more challenging environment.  

 If we look at the rage of levers (see below) that historically have been used, we anticipate that for Agricultural / Food Commodities the Supply Side competitive leverage techniques that mainly target price, will no longer be enough to deliver cost optimisation in this environment. In these markets savings are going to be driven by increased use of “Demand Side” levers such as Specification Review, Total Cost of Ownership and Business Process Re-engineering.  

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A key challenge for procurement teams will be to grow and develop the more complex “Demand Side” skills, especially on Stakeholder Engagement, needed for this scenario. One of the findings from the recent 4C Associates Procurement Reinvented Annual Report (which can be viewed on this link Download our Procurement Reinvented Annual Report ) was that “to drive performance improvement you need to invest in skills and capability, covering both technical and behavioural skills” and that although some procurement functions already have these skills and expertise in place and others have them in pockets, there was a clear need and benefit for majority of respondents to develop further. Going forward we believe developing the more complex skills required for the “Demand Side” levers will be critical for repositioning procurement to deliver its objectives as businesses adapt to the changed environment. 

For an informal discussion on Food & Beverage market please contact Kevin Moore, kevin.moore@4cassociates  or  Mark Boswell,, Head of Food & Beverage Practice at 4C Associates  

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