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An Assessment of Price Volatility in
Recyclables Markets and Market Mechanisms to Stabilize Prices
North Carolina State University, Raleigh, North Carolina, U.S.A. 
February 2001

Study Available -- Price: $20 -- Order form.

EXECUTIVE SUMMARY

INTRODUCTION AND OBJECTIVES

The past decade has witnessed explosive growth in the recovery of recyclable materials.  This growth has created the need for financial mechanisms by which recyclables are exchanged between the waste management industry that collects and often sells recyclables and the commodity industries that ultimately convert recyclables back into salable products.  From the sellers' perspective, the sale of recyclables represents a part of their revenue stream that unlike collection and tipping fees is not entirely predictable.  Large changes in the sale price of recyclables in the midst of a service contract to collect or separate recyclables can result in financial hardship or even ruin for a waste management company.  Thus, for many market participants, avoiding or managing the risk of price fluctuation is desirable.  Mechanisms like futures markets and forward contracts offer the potential to insulate participants from this risk.

The objective of this study was to evaluate the viability of risk management alternatives by (1) uncovering the extent to which prices for recyclable materials fluctuate and (2) evaluating mechanisms that could help the waste management industry manage price risk.  In this report, the potential for establishing futures markets for recyclables is examined.  Because this examination requires precise definitions of the materials to be contracted, existing technical standards for recyclable materials are first evaluated.

APPROACH

The study focused on the financial relationship that occurs once recyclable materials are ready for sale.  Because price volatility may vary by material, the study was restricted to the following common recycled materials:

• Old newsprint (ONP);

• Old corrugated containers (OCC);

• Mixed paper;

• High density polyethylene (HDPE);

• Polyethylene terephthalate (PET);

• Used aluminum beverage cans (UBC); and

• Container glass (including clear, brown, and green).

The evaluation relied on interviews, the literature, and public data.  The participants on both sides of the market for recyclables were interviewed.  Those interviewed included (1) sellers such as waste/recyclable collection companies, Materials Recovery Facility owners, and governmental unites and (2) buyers such as processors (companies that buy recyclables from sellers, process it, and resell it), brokers (companies that coordinate sales from multiple sellers to one or more buyers), and end users (companies that produce a product from a recyclable material).  Representatives of trade associations were also interviewed.

EVALUATION OF TECHNICAL STANDARDS

The objectives for evaluating technical standards were to (1) describe existing standards for recyclable materials, (2) characterize the current use of the these standards, (3) identify potential inconsistencies between buyer and seller expectations, and (4) identify potential inconsistencies between the specifications used by buyers and those used by sellers.

The study found that individual buyer specifications rather than national standards were more frequently used to negotiate sales.  In the paper and plastic markets, end users played a significant role in determining the standards for traded recyclables, and these standards were not uniform.  In contrast, glass and aluminum end users had fairly uniform quality requirements.  There was significant give and take between buyers and sellers of recyclables regarding enforcement of technical standards in both strong and weak markets.  Ongoing financial relationships between buyers and sellers were important and influenced both the amount and price of recyclables sold.  These relationships ensured some recyclable sales during periods of weak demand.  In exchange, sellers resisted the temptation to demand significantly higher prices during periods of strong recyclable materials demand.  Movement of recyclable material was often more important to sellers and buyers than price, and even large buyers typically relied on visual inspection to verify material quality.  In general, although national standards were available for all recyclable materials, they were not always used because of unique end user process requirements.

PRICE VOLATILITY IN RECYCLABLES

The objectives of analyzing price volatility in recyclable materials markets were to document this volatility and to compare price volatility for recyclable materials to that of other commodities where futures markets have succeeded and to commodities where futures markets have failed.  Three commodity groupings were selected as benchmarks:  agricultural commodities, low value to weight ratio commodities, and commodities related to recyclables.  This last category consists of commodities whose prices could be related to the prices of recyclables because recyclables are used in the production of these commodities or because recyclables are substitutes to various degrees for these commodities.  Agricultural commodities were chosen because they are generally considered to have high price volatility.  Commodities that have a low value to weight ratio were chosen because their prices are expected to be more susceptible to regional conditions.  The variance of price indexes for selected commodities is presented in Table ES-1.

The comparison commodities were ranked in descending order by the relative size of their price variance.  Agricultural commodities have the highest variances, and low value to weight ratio commodities have the lowest.  All of the non-agricultural commodities have price index variances less than 15.   The story is quite different for recyclables as illustrated by the typical data presented in Table ES-2.  Most of the recyclable price series have variances greater than or in the top extreme of the comparison range.  This is the case whether the series is from Bureau of Labor Statistics (BLS) or Recycling Times data, across regional markets, or for different periods of time.  The study found that recyclables are characterized as having high price volatility.  Moreover, prices for different types of recyclables tend to move together, both across time and across regions.

THE USE OF FUTURES MARKET, FORWARD CONTRACTING, AND VERTICAL INTEGRATION TO MANAGE PRICE RISK IN THE RECYCLING INDUSTRY

Finally, the work on technical standards and price volatility was synthesized, so the feasibility of futures markets for managing price risk in the recycling industry could be explored.  In evaluating futures markets, two things must be understood.  First, price volatility cannot be eliminated.  Individual buyers and sellers can only take actions that will reduce the variability in the prices in their transactions and not variability in the market price.  Second, price volatility in and of itself is not a problem.  A problem arises when price volatility results in net revenue instability, which depends on the spread between input price and output price.  For example, a waste paper broker who simultaneously buys and sells, always charging a price that will cover his handing costs, enjoys a stable net revenue no matter how dramatic price changes might be.  In contract, a processor who requires a long time interval between purchases and sales is concerned with varying prices because they cause net revenue to vary.  Several methods are possible for managing price risk.  The development of a futures market is one.  Others are the use of forward contracts and vertical integration.  Because the market price is unaffected by a single trader's use of these mechanisms, lowering the cost of price risk to the individual firm is accomplished by either sharing price risk with a trading partner or shifting the price risk entirely to a trading partner or third party.  Futures markets allow traders of a physical commodity to hedge against price movements by shifting the risk to a third party.  Forward contracts allow trading partners to fix the price, or a mechanism for determining the price, prior to the actual delivery.  This enables the trading partners to share price risk in any way they choose.  Vertical integration incorporates the exchange of the physical commodity into a single firm, which separates the transaction from the market price.

Currently, futures markets do not exist for recyclables and based on a review of conditions that must exist for futures markets to succeed, it is unlikely that they could be successfully developed.  Lack of commodity standardization, the absence of spot price information, and the absence of easily deliverable commodities limit the usefulness of futures contracts as a hedge.  Furthermore, close buyer-seller relationships exist in the recycling industry, but prices fixed by contract was not observed.  Because fixed contract prices would be easy, their absence suggests that price risk-bearing costs are not large despite the high volatility in recyclables prices.  Low risk-bearing costs imply little demand for hedging.  As a consequence, should futures contracts in recyclables be initiated, they would likely be lightly traded and the contracts would fail.

While futures markets for recyclables likely would not be viable, the use of more forward contracting is certainly possible.  The fact that forward contracts are not more prevalent in the sale of recyclables suggests that price risk-bearing costs are not presently so large that buyers and sellers demand such contracts.  Should firms in the waste industry, or segments thereof, determine that forward contracting would be advantageous, such contracts would be implemented.  In the case of the hauler, who must bid for contracts based on the cost of collection minus some revenue, revenue sharing programs with the recyclable generator could be developed such that the price risk is shared or transferred to the generator.  Similarly, should firms decide that more extensive vertical integration would be advantageous, they would undertake such integration.

Table ES-1
Variance of the Monthly Percentage Change in the Price Index Bureau of Labor Statistics Comparison Series^a

^aThe data are based on series that run from 12/86 to 4/98 with a base of 12/86.  Data have been deflated by the producer price index (ppi).

Table ES-2
Variance of the Monthly Percentage Change
in Recyclables National Series

^aThe data are based on the Bureau of Labor Statistics series that run from 12/86 to 4/98 with a base of 12/86.  Data have been deflated by the producer price index.
^bThe data are based on Recycling Times series that run from 12/93 to 4/98 with a base of 12/93.  Data have been deflated by the producer price index.
^cHG = High Grade (drinking and pulp substitute).

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