Commodity Prices, Convenience Yield and Inventory Behaviour

Markets for mineral commodities serve for delivering resources extracted from the earth to consumers. Price dynamics on these markets depend on the behaviour of commodity traders holding inventories. In this chapter, we examine a commodity market model with economic agents acting on the demand side and extracting utility from holding storage. In this model, commodity price fluctuations are driven by stochastic supply shocks. The market equilibrium dynamic is described by the stochastic difference equations for the commodity price and the convenience yield, which indicates the marginal utility of inventory holding. We show how the inventory behaviour of traders contributes to the autocorrelation of prices. Analysis of the model reveals the cases of price-stabilizing and -destabilizing inventory behaviour. In the former case, inventories are adjusted to smooth price fluctuations. In the latter case, the demand for inventories reinforces a price change caused by supply shock.