A strategic commodity is a commodity that is extremely important to a nation. If for any reason, the supply of a such commodity is gets disrupted then it directly impacts the economic stability of the nation. Not all nations have common strategic commodities.
While oil could be a strategic commodity for one nation and for another it could be Wheat. Though it may seem easy at this stage it is tough for a nation to declare a strategic commodity. Any random external event can affect the supply of a commodity. We have to assess the implications of such an event over the medium as well as the long term. If the impact is a substantial one then we may declare it a strategic commodity. And, this applies to all the commodity types like metal, agriculture, energy, etc. A nation wouldn’t think of making a commodity in ample quantity to be a strategic one.
In a competitive market, price fluctuations are common. But, large price fluctuations are something one should be concerned about. Higher prices not only indicate the supply-demand mismatch but also affects the individuals/organizations who can’t afford to pay for the commodity anymore. On the other hand, if the price goes down then it affects the producers of the commodity. They may choose not to produce the commodity in similar quantities next season or year. Lower prices may discourage them. But, the same rule won’t apply to all commodity types.
For instance, when it’s oil, a company can easily halt its extraction if it thinks it won’t get the support of prices in the future. But, such a thing rarely happens. It takes time for things to adjust. And, there is already a glut by the time one realizes that commodity demand isn’t there. One can’t just halt the production of a commodity just on the basis of a forecast. If it does then it pushes the price only higher.
And, then there are associated carry costs. In case someone is ready to pay carry costs i.e. costs incurred to hold inventory. Then, when the commodity is sold the producer expects to be compensated for the carry costs as well. If that doesn’t happen then there is hardly any incentive to hold the commodity. Producers would straightaway sell the commodity instead of waiting for favorable market conditions. If there is an excess supply then it needs to be absorbed first. The producers then curtail the production which will later lead to higher prices again.
Such a chain of events may affect the supply of a commodity. And, the fluctuations need to be curtailed. And, that is where the concept of Strategic reserves for the strategic commodity comes in.
For instance, the US has a Strategic Petroleum Reserve (SPR) with 714 million barrels of authorized storage capacity. So, if the situation demands the release of SPR oil then it is sold in the market. It is done to restore the oil supply and restrict large price fluctuations. Similarly, other nations have built their strategic reserves for other commodities they deem strategic.
Not only strategic reserves but nations also take other measures as well which include export restrictions, push policies that provide an incentive for the producers to produce more of the commodity, etc.
Though it may take some time to produce the commodity so the best way to stabilize the markets initially is to release the commodity from the strategic reserve. And, the supply from producers can chip in later.
It is good to build strategic reserves when prices are lower and release them when prices go high.
That way, large price fluctuations can be minimized. It not only helps consumers but also the producers. They know they can recover their costs and contribute to building strategic reserves if the need arises.