Brussels, 2 February 2011
Questions and Answers on the Communication on Commodity Markets and Raw Materials
Commodities & Raw Materials: what is at stake?
A raw material is an unprocessed natural substance or mineral used in a manufacturing process for providing finished goods. Raw materials are often natural resources such as gas, bauxite or wood.
A commodity is any product which a low value added and thus very sensitive to price competition. Raw materials, agricultural products and basic goods are commodities.
Commodity markets – both the physical markets where these materials are traded as well as the financial markets derived from them - have seen increased volatility and unprecedented movements in prices in recent years. While the precise causes of these price swings are often difficult to pin-point, concern over the possible effects which financial market players have on basic prices, as well as concern about the level of transparency existing in these markets, have given rise to calls for policymakers to take action.
Beyond commodity price volatility, in recent years, some countries have introduced restrictions on the export of certain vital raw materials - such as rare earths for instance gallium, lithium and indium and some other minerals important because of their increased use in new technologies). These restrictions, as well as other bottlenecks in the sustainable supply of raw materials, pose a real challenge for European industry and consumers and need to be tackled.
What is the European Commission doing to tackle these issues?
The purpose of the Communication is to propose a way forward for how these challenges can be addressed in a coherent and comprehensive manner.
On commodity markets, while the Commission is already acting to improve the transparency and integrity of commodity markets, further work needs to be done to fully appreciate the interaction which exists between financial markets, increased global demand and physical commodity prices.
In 2008, the Commission adopted an initiative on Raw Materials. It outlined a strategy based around three pillars:
Fair and sustainable supply of raw materials from global markets
Fostering sustainable supply within the EU
Boosting resource efficiency and promoting recycling
Since then, the Commission has:
identified for the first time a list of critical raw materials
has identified good practices in order to promote mining in Europe
has tackled unjustified trade restrictions abroad
has fostered greater recycling and more efficient use of materials.
In today's Communication, the Commission reinforces the above strategy presenting a series of targeted actions aimed at meeting our future raw material supply needs.
Why is secure access to raw materials so important for Europe?
Raw materials - such as metals and minerals - are the basic building blocks for the products we use on a daily basis. Hence, the continued, fair, sustainable and affordable supply of these materials is essential for the EU economy and our way of life. Moreover, given their importance for future technologies, they are also an important part of our future, both economically and to meet environmental goals. The table below gives an example of a number of raw materials and what the final product they are used in are:
Electric and electronic goods
Flat display panels
Batteries in electric cars/ICT devices
Platinum Group Metals
Catalysts & mobile phones
Permanent magnets for windmill and hybrid cars lasers, LCDs
What do we mean by the interface between physical and financial markets?
Financial and physical commodity markets are linked in multiple ways. Participants can be active on both and react to price developments in one market by taking a position in the other. With increased interdependence between markets, developments in financial markets unrelated to underlying commodities can also trigger investment or hedging decisions in relation to commodities. Further, prices in derivative markets can be directly transmitted for example by indexation to wholesale and retail spot prices. Identifying which way causation flows in the interaction between financial and physical markets is a complex issue, complicated by differences across commodity markets and a lack of transparency on both physical and financial markets.
What is the evidence of speculation on these markets and what impacts do they have?
Recent years have seen large-scale new investment flows into various commodity derivative markets with varying effects on prices. Some of these speculative flows are based on an assessment of market fundamentals such as the outlook for supply and demand in a given commodity. In other cases, they may be entirely disconnected from the fundamentals of the commodity sectors in question and instead seek to profit from market movements. The effects of both types of investment flows on prices have been already been studied but conclusions vary and further analysis is necessary in order to better understand these developments. Speculation, investing, and hedging are complementary market activities which are not always distinct or mutually exclusive. Neither should speculation be confused with market manipulation. Nonetheless, recent developments have made understanding commodity prices more difficult. Additional transparency and oversight of commodity derivative markets is therefore necessary.
What is the Commission doing to improve the integrity and transparency of commodity derivative markets?
In light of recent developments and concerns expressed over the functioning of commodity derivatives markets, the Commission is taking a series of measures to improve how financial and commodity markets function and to reinforce regulation in line with G20 commitments.
The Commission adopted in September 2010 a proposal for a regulation on Over The Counter derivatives, which aims to reduce systemic risk and improve transparency for regulators in all derivatives, including commodity derivatives. We hope to see an agreement before the end of the year on this proposal.
The review of the Markets in Financial Instruments Directive due before the summer 2011 and on which the Commission is currently consulting will aim to improve further the transparency of trades and prices in commodity derivatives, including by setting conditions for when commodity derivative products should trade exclusively on organised trading venues. It will also explore the need for more systematic and detailed information on the trading activities of different types of market participants in commodity derivatives, and more comprehensive oversight by regulators of commodity derivative positions, including the need for imposing position limits when deemed necessary. The consultation also asks whether position limits should be introduced in certain cases.
The review of the Market Abuse Directive – due before the summer - will aim to clarify what trading in commodity markets constitutes abuse, and to ensure that all venues and transactions where abusive practices can occur are properly covered under pan-EU rules.
The work on Packaged Retail Investment Products (PRIPS) will examine the need for additional rigour and enhanced quality of information when retail investors are offered products such as some structured commodity investment products.
The Alternative Investment Fund Managers Directive, which was agreed in November 2010, will increase transparency of these funds for investors and national supervisors, and give a better insight of the impact of these funds on the markets for commodity derivatives.
Finally the creation of the European Securities Markets Authority (ESMA) started its work in January 2011 will ensure consistency of technical rules applicable to these markets and be instrumental in strengthening collaboration with regulators of the underlying physical markets.
What are position limits, and how could they be useful?
A position is the relative share of the market occupied by one given investor. They currently do not exist in the EU.
Position limits can be set in two forms. First, competent authorities can be given the power to direct any individual person to reduce the size of their position in the interests of the orderly functioning of markets, investor protection, or market integrity.
Second, ex-ante position limits can be set for a particular market (for example you could say no investor can control more than x % of the market of copper). Such limits can apply to both derivative contracts traded on exchange and over-the-counter.
Position limits can help to ensure orderly functioning of the market, for instance by preventing settlement squeezes (i.e. when all contracts have to be executed on a specific date) and other forms of market abuse, as well as help to control excessive speculation.
In order to be able to set position limits, as well as in order to monitor market developments, competent authorities should be able to request anyone entering into a derivative transaction to provide a full explanation for their position. Position limits should take account market developments, the specificities of the different types of derivative products and, in the case of commodity derivatives, the evolution of the physical market of the relevant commodity.
In the MIFID consultation, the Commission has asked stakeholders for their views as to the possible introduction of position limits in the EU. If these were introduced in the EU, they could allow competent authorities to examine the positions taken by traders, and to require them to decrease the size of their positions if needed.
Why are some materials considered to be critical to the EU?
The Commission has identified in this Communication a list of 14 raw materials which are subject to a higher risk of supply interruption and are highly important to the economy;
There are a number of reasons for a heightened supply risk, one of which is high concentration of the production of a raw material in a given country. The graphic below presents the ‘critical’ materials by source country.
Supply risk may also be accentuated by the low political-economic stability of the main supplier(s), as well as by low substitutability and low recycling rates of the raw material itself.
The Commission will monitor the issue of critical raw materials to identify priority actions, and will examine this with Member States and stakeholders. The Commission will update the list regularly.
Does this mean that other metals and minerals are not seen as important?
No, on the contrary. Minerals, such as lithium and iron ore, and metals, such as nickel and copper nickel, have been and will continue to be key or essential for the EU’s economy. This goes without saying. Nonetheless, as these materials are not subject to a risk of short term supply disruption, they are not categorised as being ‘critical’. That said, maintaining undistorted fair and affordable access to these raw materials will remain a priority.
How is coherence between raw materials and development policies ensured?
Tackling excessive price volatility will also benefit developing countries, whether they are importers or exporters of raw materials. Furthermore, the Communication addresses the relationship between financial transparency, tax and mining, an issue which is of fundamental importance to resource-rich countries. Finally, the Commission will look closely at controls on minerals originating in conflict areas.
As an example of the EU’s commitment to help developing countries to use mining as an instrument for development and poverty reduction, as part of the EU-Africa Joint Strategy for 2011-13, agreement was reached to co-operate in three main areas: governance, investment/infrastructure and geological knowledge/skills. This co-operation will also explore how resource rich countries can better link the extractive industry to local industry and communities.
What specific measures are proposed on raw materials & trade?
As the EU is highly dependent on imports of a number of metals, the fair application of trade rules on raw materials will continue to be a priority for the Commission. As such, the Commission will continue to integrate raw materials provisions in ongoing trade negotiations, where appropriate. It will also step-up enforcement of existing rules by tackling illegal trade barriers.
In light of the EU’s external dependence on certain metals, is there a potential for mining in the EU?
Yes. Although the EU is very import-dependent on metals, Europe is endowed with strong industrial minerals and building materials industries. Moreover, despite dependence on metals imports, there are important deposits of many metals in many regions of the EU. Therefore the potential for mining in Europe is strong and many Member States are making use of their deposits. However, in spite of this, many barriers to mining exists, some of which are administrative and some which are often due to the sector being subject to various overlapping and conflicting policies.
What are the main proposals put forward for fostering mining in Europe?
The Commission considers that the following practices are particularly important in promoting investment in extractive industries in Europe:
definition of a national minerals policy;
setting up a land use planning policy; and
putting in place a clear authorisation process for exploration and extraction.
To progress this, the Commission proposes to assess with the Member States, in full respect of subsidiarity, the feasibility of establishing a mechanism to monitor actions by Member States in the above area, including the development of indicators.
Another requirement for a strong European mining industry is the improvement of the EU minerals knowledge base. As this takes time to create, in the short term, the Commission proposes to work with Member States, where possible, to increase synergies between national geological surveys.
What are Europe’s ‘Urban Mines’ and why are they an important source of raw materials?
Much of the steel, aluminium and other metal inputs used by European industry comes from secondary, or recycled, sources. Indeed, given Europe’s long industrial history and high standard of living, its ‘urban mines’ stocks are a considerable source of raw material. As the reprocessing of recycled material requires less energy than processing of metal ore, recycling also saves on carbon emissions. Overall, while recycling cannot meet all of our needs, there is still much potential for greater recycling.
What does the Commission propose to do on recycling & resource efficiency?
Significant progress has been made in improving recycling rates in Europe over the last 20 years. In spite of the many successes, there is still scope for improvement.
Within the EU, there are still wide differences in recycling rates achieved by Member States, as well as between waste streams. The reasons for these differences need to be further examined. The Communication proposes to develop best practices in collection and treatment in waste, to improve, where necessary, statistics on waste and materials flows, and to support research on economic incentives for recycling.
Although a variety of rules are in place to control waste shipment, a large proportion of our waste is illegally exported to non-OECD countries where treatment often results in damage to the environmental and a permanent loss of material. To tackle this, the Commission has proposed amendments to the WEEE Directive (waste from electrical and electronic equipment) setting tough criteria for export of old electronics goods. However, further action is required to enforce existing rules. The Communication outlines a number of proposals targeted at preventing illegal exports and at ensuring that treatment facilities dealing with EU waste meet acceptable standards.
What role should EU innovation policy play in meeting our raw material needs?
Innovation can help increase the supply of raw materials in a number of ways – from new mining methods to ways in which products can be better designed for recycling to ways in which rare metals can be retrieved from waste for example. Substitution of materials, as well as finding new ways to make better use of what we already have, also plays an important role here. In order to improve innovation across the entire value chain, the Commission will in 2011 assess the feasibility of launching, under the EU2020 strategy, an ‘innovation partnership’ dedicated to raw materials.
Why is a problem for agricultural raw materials?
Market prices for agricultural raw materials have become more and more volatile in recent years, with the spikes seen in food prices in 2007/2008 causing food shortages in many regions and leading to political unrest in a number of countries worldwide. In Europe, the impact of food inflation further exacerbated the economic problems. In recent months, there have been a number of new price surges – with the ensuing problems in some cases similar to those seen 3 years ago. The causes for these price fluctuations are complex and are frequently led by climate-driven problems of production, but it seems clear that the large volume of financial market activity is a further factor. The surge in cereals prices seen last August, for example, was much more dramatic than warranted on the basis of an objective analysis of supply and demand. One of the aims of this Communication is to better understand the role that the financial markets have on these price fluctuations.
What is the link to global food security?
This increased volatility also comes at a time when global food security is facing a number of particularly important challenges. The combination of demographic growth (FAO estimates a 2 billion increase in world population by 2050), changing dietary patterns, and the pressures of climate change on our capacity to produce mean that world food supply is facing a huge struggle to keep up with demand. Latest DG AGRI market forecasts highlight that EU agricultural commodity prices are expected to stay higher than their historical averages, reversing their long-term downward trend. At the same stage the costs of agricultural production (fertiliser, treatments, petrol) are also likely to remain well above what we have seen in the past. Greater fluctuation in market prices will only further exacerbate the problems, for example in improving agricultural investment. In order to address this global problem, the Communication supports a global approach with specific reference to the G20 activities foreseen this year, where the French presidency has put priority on addressing commodity prices and food security.