Commodities: A Primer

Scott Irwin (a prominent Agricultural Economics Professor at The University of Illinois) cowrote a book with Doug Peterson called, Back to the Futures - Crashing Dirt bikes, Chasing cows, and Unraveling the Mystery of Commodity Futures Markets.  As the experts, I lean heavily on their work throughout my Substack posts to isolate some key explanations from the book.  

A commodity changing in space refers to the physical storage and transportation. A commodity changing in form refers to the transformation of the raw good into an intermediate or finished product.

In the first chapter, I think the authors do a great job explaining the underlying topics of this foundational commodities post.

“A commodity, such as corn, is mass-produced, but so are non-commodities, such as smartphones. What distinguishes the two is a million-dollar word-fungible.  Fungibility means one unit of a commodity is roughly the same as another. A bushel of corn in Illinois is essentially the same as another in South Dakota or China.  As long as they meet some basic grade characteristics, they are swappable. A smartphone is not fungible or swappable because one brand can vary dramatically from another, as any Apple aficionado will remind you (constantly). You cannot swap out a smartphone like you can with a bushel of grain.

Commodities also tend to be global in scope and typically are raw materials, such as crude oil, the world’s biggest commodity market…the world typically uses about 100 million barrels every day.  This amounts to a trillion gallons of crude oil per year.  Corn is also a massive market, with a lot of it used around the world for animal feed, fuel, and as an industrial ingredient in all sorts of food products. 

Because commodity markets are so large, they involve middle operators who transform the commodities in space, time, or form to be used by consumers. Transforming a commodity in space means moving it from one place to another. The farmer moves grain to the local elevator, which carries it to the larger terminal elevators along the Mississippi River.  Then the terminal elevators move the grain to companies that us the commodity to make food, fuel, or other products.

Second, middle operators transform commodities in form. If I own a large hog farm in China, I want to purchase soybeans in the form of soybean meal, which I feed to my pigs. Therefore, the soybeans have to be crushed and processed into meal after they’re shipped from the United States. Similarly, we don’t want to fill our cars with crude oil at the pump; we want gasoline, so the crude oil is processed into gasoline. The commodity is changed in form.”

~ Chapter 1: My Near-Death Experience

If you enjoyed this excerpt, I highly encourage you to pick up a copy of the book!