First off, did you know Nigeria had an active commodities exchange? I had no idea. It was formerly known as Abuja Securities & Commodities Exchange, and is now known simply as Nigerian Commodities Exchange . I stumbled upon it by chance, and learned as much as I could from the little of it there is online. Majority of it, naturally, is depressing. The exchange has been around for a while, but it was ran into the ground by our successive governments. Finally, last year, efforts were made to revive it and now it’s functional-ish. I guess when it comes to things like this, half bread is better than chin chin (NOT).
To backtrack though, what in the first place is a commodity exchange? Well, to put it simply, it’s a marketplace for agricultural and sometimes mining, commodities. But it’s more than just your average market, there’s a bit than just ‘trade money for goods’ going on. I’ll illustrate with a familiar story to most people in Nigeria: the story of Joseph and the seven years famine in Egypt. What is the moral of that story? By storing part of the harvest of the plentiful seven years, Joseph was able to keep grain flowing during the years of famine.
Commodity exchanges sort of work the same way. Consider a corn farmer: Let’s say he spends $50,000 in planting with the expectation that he will get 1000 bags of corn which will fetch him $70,000 eight months later. Unfortunately, when he finally gets his corn to the market, he finds out there was an excess supply of corn available for sale from other farmers and the price has crashed. So his 1000 bags now can only fetch him $45000. Instead of a $20,000 gain, he suffers a $5,000 loss and probably has to borrow $5,000 to plant another year’s crop and hope again that the prices bounce back. And if they don’t he might suffer another loss and…You see the problem there right?
Well, in a commodity exchange, our farmer can purchase contracts today that guarantee that he can sell his crop for $70,000 eight months from now, no matter what their prices at that time may be. Now, when the harvest time comes, two things could happen. A thousand bags could be worth only $40,000. However, a contract is a contract and the people he bought the contracts from will pay him the full $70,000 and take the $30,000 loss. On the other hand, corn supply may have fallen and prices climbed so his thousand bags are worth $90,000. However, it is a binding contract so again, he hands over the harvest, and they give him $70,000 and then sell it back then for a $20,000 profit. Could our farmer have made more money? Sure. But he could have also lost it. For him, he’s happy that at least he has a stable price that he is guaranteed to get, which is profitable and around which he can plan. So it works out for him.
It’s a bit more complicated than this, of course, as most exchanges establish rules and grades to standardize commodities and make them more easily tradable, to manage supply and demand, support production year round, and more. There’s literally no end to the complexity and specialization of a commodities contract. You can buy insurance against price changes, interest rates, storage costs, anything.
One of the biggest commodity markets in the world is in Chicago, and they trade everything from pork, cattle, milk, butter, peanuts, wheat, corn whatever agric produce and numerous derivative contracts. Ethiopia recently established an exchange to standardize coffee production, sales and more, in addition to other crops and it’s been a big boost to their economy as well. Warehousing, standardized prices and better delivery raised coffee revenue in Ethiopia from $500m+ to over $700m in the first year the exchange was established.
I’m glad to find that Nigeria is working along the same path, and also to learn that we had Africa’s third largest cocoa harvest in the past year. A lot of things still need to be put in place to help grow our commodity exchange but the fact that we’re working on it once again (and privatized too), is rather good news. Heirs Holdings, the private equity firm co-founded by Tony Elumelu is actively building or investing in good quality commodity exchanges around Africa. More grease to their elbows.
One of the biggest challenges the development of commodities exchanges will help us solve, especially in Nigeria, is financing. Right now, it’s hard to provide financing to farmers because there isn’t a set price for whatever they grow, it is mostly whatever they get when they finally sell and how desperate they are to sell it. That makes it hard to plan or budget revenues and invest accordingly, which makes it hard for a banker or investor to predict the financial performance of an agricultural venture and assess them for creditworthiness or cashflow. If exchanges help make pricing stable, predictable and efficient, they will go a long way to boosting the sector and improving the Nigerian economy.
Let’s hope, and work for that.