Is it Time for Broker-Dealers to Adapt Their CFDs to the Uneven Impact of Climate Change?

Commodity trading is a practice as old as time. But as climate change pushes soft commodity markets into more aggressive volatility, should broker-dealers place their reliance on contracts for differences to find value as their performance becomes increasingly influenced by the environment?

While there is much market uncertainty surrounding commodities, post-pandemic interest in trading them has accelerated at a breathtaking pace. McKinsey data shows that the total trading EBIT of various commodities grew from $27 billion in 2018 to $104 billion in 2023.

Although much of this recent growth will have been driven by the energy implications of Russia’s war in Ukraine, the fact that trading almost doubled between 2018 and 2021 indicates a more sustained trend has been underway.

This dynamic suggests that commodities are once again a leading consideration for broker-dealers on a global scale, but growing volatility surrounding assets calls for a far more nuanced approach to portfolio management in this field.

Welcoming new players to this economic landscape is a good thing, and more vibrant trading volumes can help to increase value pools and even welcome new sustainable technologies to the landscape.

This means that investing in soft commodities could have a positive environmental impact. But it’s fears over climate change that are set to pose fresh opportunities and challenges to broker-dealers in the coming years.

Commodity Volatility as the New Normal

The impact of climate change poses a significant risk for both the trade of agricultural commodities and food security alike.

Natwest data suggests that between 1990 and 2020, over 420 million hectares of forest had been lost to deforestation, with more than 90% of these losses taking place in tropical areas. Deforestation contributes to between 12% and 20% of global carbon emissions and has the potential to offer up to 37% of the greenhouse gas mitigation that could help to stabilize global warming to 2°C by 2030.

The challenging environmental landscape has had a profound impact on the FAO Food Price Index (FFPI) volatility, which JPMorgan has claimed closely follows oscillating warming and cooling pattern (ENSO) weather cycles.

With El Nino and La Nina weather cycles becoming more commonplace, severe weather conditions have consistently impacted food price inflation, and events like hurricanes and storms can adversely affect crude production and refining activity.

The emergence of higher oil prices can weigh heavily on crop prices, and historical trends show that food price inflation can be coupled with higher energy prices due to increased costs for fertilizer, fuel, and transportation weighing into agricultural production margins.

As the world is forced to cope with climate change as the new normal, commodity volatility will invariably become more common. Even outside of production, drought in Central America has impacted trade through the Panama Canal and global supply chains are having to become increasingly adaptable to delays and drawbacks for a number of environmental and geopolitical reasons.

But what does this mean for institutional investors? For one, it could mean fresh opportunities and challenges presented by contract for differences (CFD) investing.

Why Climate Change Could Empower CFD Investing

Utilizing contract for differences (CFD) as a trading tool, institutional investors can trade the price movement of commodities by speculating on whether their value will rise of fall in the short term.

This can hold more benefits for investors when it comes to margin trading, empowering investors to easily adopt long or short positions in commodities using CFDs. Because institutions hold CFDs as opposed to the asset itself, there are generally no short-selling rules associated and instruments can be effectively shorted at any time.

This means that broker-dealers can make money from the trader paying the spread, which means that the trader pays the ask price when buying but takes the bid price when selling or shorting. In turn, the broker-dealer can take a piece or spread on each bid on the price they quote.

Given the impact of climate change on soft commodities, CFD investing can hold significant opportunities for broker-dealers. With weather events capable of having a profound market impact, various commodities can be impacted in different ways by a variety of external factors.

Measuring the Uneven Impact of Climate Change

We’re already seeing climate change have a profound impact on institutional interest in commodities.

This year, February saw commodity traders bet heavily on a slump in grain prices as prosperous harvests led to a supply glut of commodities like corn, wheat, and soybeans. As a result, a net short position of 546,000 futures were placed across the three crops, representing the largest negative bet in almost 20 years.

However, by May the price of wheat soared on the news that crop damage from dryness in the Black Sea could bolster the commodity’s scarcity.

It’s these factors that underline the uneven impact of climate change on commodities. As Earth’s temperature continues to rise, commodities that could only be harvested in tropical climates are becoming more resilient. In the case of coffee, rising temperatures are making it possible for beans to be grown in Europe in a move that could rapidly grow production.

More production is generally bad news for investors because of oversupply, which can adversely impact the scarcity and value of commodities.

This is the case for the likes of wheat and corn, too. However, adverse weather conditions mean that there’s a greater prospect of crop failure, which can increase the price of the commodities due to greater scarcity.

The climate emergency may have further ramifications for commodity volatility. Commodities like cotton could one day help to provide a sustainable alternative energy source, helping to illustrate how necessity could continue to breed innovation.

Finding Profitability in Volatility

Already, it’s clear that CFDs can form a symbiotic relationship with volatile commodity markets for broker-dealers that have the resources to make decisive market movements.

Successfully trading commodities requires a significant emphasis on fundamental analysis and rapid reaction times when emerging environmental news offers wider ramifications for markets.

With this in mind, having access to tailored prime services that offer quantitative pricing across a vast range of proprietary Index and Commodity CFDs to cater to the dynamic requirements of these markets is essential.

For institutions, soft commodities will continue to become a major tool in leveraging prosperity over the coming years.

It’s for this reason that making adjustments to investment research and the identification of opportunities should take place sooner rather than later. The impact of climate change on commodities will become increasingly complex, and this means that resourceful broker-dealers could be in prime position to secure portfolio growth.