When should a company like higher raw material prices?

Away from the G20 summit last month the CEO of Nestlé, the worlds largest food company gave some revealing insights into his thoughts on recent commodity price movements affecting their business.

In the interview with the Wall Street Journal (WSJ) the CEO Paul Bulcke was asked whether Nestlé had benefitted from the recent drop in coffee, cocoa, sugar and milk prices and whether the savings had been passed onto its customers.

“We don’t price our products on the peaks. Four years ago, milk all the sudden went from $1,800 a ton to $5,500. We didn’t multiply the price of our products by four. We said $1,800 was definitely too low [and] saw a sustainable [range] of $3,000 and $3,500. And guess what, we are down to $3,500. Part of our job is to try to read through these turbulences and not create the same nervousness on [retail] prices as [our] raw materials.”

It should be noted that the fact that key raw ingredients only comprise 12% of sales is a big factor in why changes in commodity prices are not fully reflected in retail prices.

When asked what the outlook for commodity prices Bulcke answered

“The underlying trend is definitely going up and I’ve found it even positive [for us]. When demand and supply are tense you start to have higher volatility, which is normal…so now that prices are going up it starts to be something that is of interest [to governments]. Remember, we have to prepare ourselves to feed nine to 10 billion in a few years. The technologies, the practice and new ways of going about agriculture are all there. We have to embrace it.”

When asked if there is anything Nestlé can do to help alleviate food shortages in developing countries responded by saying that more efficient supply chains can help, reducing food wastage in particular.

“There must be access for farmers to the market; 30-40% of all that is produced in the fields is not really consumed. In the developing world, it is because it doesn’t get to the market because of infrastructure…We are setting up new kinds of factories that are closer to the consumer. That creates faster and shorter supply chains.”

While better infrastructure will help farmers in developing countries by reducing wastage it clearly helps Nestlé too by ensuring that the raw ingredients are consistently higher quality and delivered on schedule.

Nestlé has set up commodity research teams to identify trends, while the company uses futures contracts, hedging to lessen its exposure to price swings and by buying directly from farmers with whom the firm has a long-term relationship.

Kevin Petrie, Nestlé’s head of procurement, in a separate WSJ interview last year highlighted how far ahead they look when managing commodity price risk.

“We are always managing 18 months ahead. Because of the volume of these commodities it is crucial for our managers to understand the prices of the commodities.”

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El Nino risk rises heralding more commodity price volatility

First Published at www.oilprice.com

Latest forecasts from the US Climate Prediction Center and the Australian Bureau of Meteorology indicate that climate conditions continue to shift towards El Niño later in 2012. The weather phenomenon results in warmer waters in the Pacific increasing the risk of rain impacting crops in key agricultural regions while also reducing the incidence of tropical storms in the US Gulf, a key oil producing region.

El Niño is a warming of sea surface temperatures in the equatorial Pacific that occurs every 4 to 12 years. El Niño events have occurred in 2002/03, 2004/05 and 2009/10.

Forecasters have found that the number of warm spots across the central Pacific has grown. El Niño type conditions often form several months before it is officially declared suggesting that current observations may result in an El Niño forming by September.

In terms of commodity producing regions, El Niño typically results in drier conditions across Australia, other south east Asia and Brazil but wetter conditions around the southern US states and coastal areas of South America.

Impact of El Nino

El Niño reduces US Gulf storm risk while bringing extreme winters to the US

El Niño increases wind shear in the Atlantic acting as a block to tropical storms from forming. So far in 2012 there have been four tropical storms, with just Tropical Storm Debbie resulting in the loss of 44k bbls per day for a brief period.

The most recent forecast from Colorado State University points towards a further 9 tropical storms, 5 hurricanes and 2 major hurricanes. If El Niño does develop further there is likely to be few storms in the US Gulf and less upward support to oil prices.

In El Niño events, portions of the US Midwest tend to experience a much warmer than normal winter, while the southeast US tends to experience wet and cool conditions. Whichever impact is greater has implications for US natural gas prices.

Agricultural commodity prices likely to see further gains

Apart from the energy sector, global agricultural production could also suffer massive disruptions from the warming caused by El Niño.

In South America drier conditions in Brazil and Argentina (key producers of sugar, coffee and soybeans) may see their crops damaged as prolonged heat can damage yields. Meanwhile further south copper producing areas of Chile are likely to see an increased risk of floods impacting copper output.

In South East Asia El Niño typically results in drier conditions. As with other crops prolonged heat can damage yields. The region is home to 90% of global palm oil supplies, 40% of the words wheat production and the bulk of natural rubber output.

El Niño can have positive as well as negative economic impacts

The 1997/98 El Niño was particularly strong and so its impacts may not reflect future El Niño events but they give an example of the scale of the economic impacts.

In the USA agriculture sector losses were estimated at $1.5-1.7bn in 1997/98. Meanwhile warmer weather resulted in a reduction in heating costs of some $6.7bn.

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