Extreme weather demands commodity hedge instruments

Increased frequency of extreme weather related catastrophes due to changing patterns of temperature and rainfalls and rising water levels is threatening the global food security and is increasing the risk of commodity investors, agriculturists and agrarian economies. Economists believe that extreme weather events would be one of the most important factors in commodity price determination in the coming years. Since the frequency of extreme weather events is expected to rise in next decade. Extreme rainfall and cyclone which completely paralysed coal mining in Australia, flooding in Thailand which destroyed rice fields and stagnated the auto component making sector of the country and the Russian wheat losses due to heat wave and droughts are a few examples of extreme weather events witnessed in the year gone by. The prices of commodities rose immediately after these natural disasters. From coal in Australia, coffee in US, to rice in Thailand and in numerous other cases, an immediate surge in commodity prices was seen. Due to globalisation very often the effects of such events are felt all across the globe. These events not only resulted in losses to farmers and businesses but due to the large futures and spot commodity exchange markets, investors who had taken positions in these commodities also had large losses. So the question that is left unanswered is how the farmer/businesses (hedgers) and investors (speculators) mitigate risk? The easy access and availability of commodity exchanges and financial instruments (default swaps, etc) and the knowhow about the working of these in developed economies, make it lot easier to mitigate risk by taking opposite positions. For example, a rice farmer or coal miner can insure against flood losses by purchasing rice/coal future contracts, hence if there are losses due to bad weather, the farmer/miner makes up for the losses on the future contracts as the commodities would be short in supply and prices would most likely be higher. However, since the Pakistani commodity exchange is still in its infancy and there is not enough awareness about financial instruments and their usage to curtail risk Pakistanis would be left at the mercy of Mother Nature. Hence, there is a dire need to bring in commodity spot and future contracts and different types of swaps, like credit default swaps. In addition, awareness should be created so that people can use these instruments to hedge and reduce the risks.