When up can mean down: Do fluctuations in the cost of raw materials have a direct impact on the the price that consumers end up paying for the product? David Bowen traces the divergent lines

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The Independent Online
IT IS tough being a giant retailer. On Monday, Sainsbury increased the price of its roast and ground coffee. On the same day the price of coffee on the commodity markets leapt by 25 per cent as a result of a fierce frost in Brazil, and Sainsbury had to issue a 'clarification' to counter stories that it was reacting with lightning speed to the jump. 'We buy our coffee up to three months in advance. This increase was caused by fluctuations in the commodity market at the beginning of the year,' it said.

The supermarket group was right: the worst it can be accused of is bad timing. But the affair does raise an intriguing question. What exactly is the correlation between the price of raw materials and the price that the customer pays for the finished product?

This is a particularly relevant question now. Commodity prices have been on the rise since the end of last summer, with oil, coffee, rubber, aluminium, silver, cotton, wool and palm oil all at least 30 per cent more expensive than they were a year ago. If these prices have a substantial knock-on effect, not only will they boost inflation, they could slow the speed of economic recovery.

It is impossible to trace the effect for metals and other industrial materials, but rather easier for consumer commodities that reach the customer without too much processing.

The graphs on this page map commodity price changes against retail price changes, as measured by the Central Statistical Office for use in its Retail Price Index. They paint a confusing picture: some retail prices do indeed follow 'their' commodities closely; others bear absolutely no relationship to them. Often, retail competition and currency movements are far more important than any volatility in the raw material markets.

The oil companies are more used than most to defending the apparently indefensible. When the crude oil price tumbles, petrol prices never seem to fall. When they rise, they appear to follow immediately.

The graph here compares price movements in four-star petrol with those of premium gasoline - essentially the same product, but as traded on the Rotterdam market. The oil majors are keen to point out that this market is separate from that which controls crude prices, though they accept there is a close correlation in the long run.

But there is no correlation at all between traded gasoline and petrol prices. The price of a litre of four-star has tended to rise over the past three years while gasoline prices have tended to fall. The case for the prosecution looks strong.

The trouble is, the cost of the product itself is a fraction of the retail price - 15.8 per cent, or 9.3p of the recommended maximum of 58.9p per litre, according to BP. BP takes 5.7p for itself, the retailers get 2p - and the Treasury 41.9p, or 71.1 per cent of the price.

The 9.3p a litre translates into roughly dollars 175 ( pounds 112) a tonne (the latest Rotterdam price), which suggests the oil companies are not such rogues after all. BP says the forecourt price rises are entirely driven by the four Budget tax rises since the start of 1991, which have added an extra 13.6p a litre.

The Rotterdam price of premium gasoline has risen by almost 30 per cent since the New Year - which should have pushed the retail price up by about 3p. But that is not the case. First, currency movements play a part, because oil is priced in dollars. 'The collapse in the dollar has to a great extent shielded European consumers from the increases in raw material prices,' says Robert Olle, director of the consultancy Opal.

Local market conditions can be even more important. If a new Tesco supermarket has opened with its own forecourt, it will almost certainly be offering cheap petrol, and the oil companies will support their local outlets so they can match the prices. In the low-competition, remote Highlands and Islands, by contrast, petrol can be more than 10p more expensive than in the rest of Scotland.

Tea is hardly taxed, yet its price bears little relation to the price raised at the famous London tea auctions. Illtyd Lewis, executive director of the Tea Council, says that only 25 per cent of the tea the British drink is purchased at the auctions.

Although the auctions sell teas of a certain quality, their origins vary. 'One day their high-quality tea could be Ceylon, the next day African,' says a Brooke Bond spokeswoman. Like Scotch, most teas are blended: PG Tips has 20 to 30 different teas, which are carefully mixed to provide a consistent taste. That is why companies such as Brooke Bond have to buy from around the world to find the mix they require. 'The London auctions do not provide the flexibility we need,' the spokeswoman says.

Though local prices vary enormously, the geographical spread of this purchasing means that fluctuations in the final price are ironed out. While a frost in Brazil has a dramatic effect on coffee prices, a flood in Sri Lanka or a drought in Kenya will have only a limited effect on the price of a cup of tea.

The supply of Rwandan tea, used in good quality products such as Brooke Bond's Choicest Blend, has dried up. This has forced up the London auction price of quality teas from 190p to 280p a kilo but, the company's spokeswoman says, it will be able to substitute tea from Kenya, so there is unlikely to be much knock-on effect.

Competition at home is the real driver behind the price of tea. At 2p a home-brewed cup, tea benefits from recession, and has increased its market share in the past few years. But the supermarkets have been pushing their own brands hard, and the big names have been fighting back. Brooke Bond, owned by Unilever, closed one of its two factories in 1992, and has concentrated all production in Manchester in an effort to cut its costs.

Sugar is another baffling area. Common sense suggests that the price of a bag of white sugar should be closely linked to the London Daily White Sugar Price: all that is needed, after all, is to put the stuff in a bag and sell it. Not so. 'White LDP refers to world-traded sugar, which bears only a passing relationship to the internal European Union price,' a Tate & Lyle spokesman says.

Sugar beet is an extremely important crop in Europe - which means that the normal laws of the market have been suspended and replaced by a system devised in Brussels. Even though Tate & Lyle makes its sugar from foreign cane (its biggest suppliers are Mauritius and Swaziland), its price is under similar controls through EU arrangements with former colonies.

A minimum price, designed to ensure beet producers can make a living, is set by European ministers each year. It has not changed for the past three years, which explains the comparative stability of the sugar price in the shops.

What movements there have been come from exchange rate changes, and competition between retailers. The intervention price is set in European Currency Units. When an individual currency moves against the ECU, the price the farmers receive - and the buyers pay - moves with it. Prices moved up by pounds 100 a tonne at the end of 1992 as a result of 'Black Wednesday' in September, before the strengthening pound pulled them down again.

This does, however, explain why the price of sugar has gone up in British shops over the past three years, while in France, land of the franc fort, it has stayed steady.

Even in sterling terms, though, the intervention price has stayed remarkably steady: at the end of 1992 it was pounds 521 per tonne 'naked ex refinery'; a year later it was pounds 514, and now it is pounds 524.

Retailers have been pricing sugar keenly, to bring customers into their shops. Tate & Lyle pays pounds 500 a tonne for unrefined sugar, and most wholesalers would pay pounds 700 to pounds 800 a tonne for the refined version. However, some retailers have been selling sugar at 49p a kilo (or pounds 490 a tonne) - which suggests they are using it as a loss leader. 'If they want to lose money on it, that's up to them,' Tate says.

Coffee is a relief: the retail price really does follow the commodity price, though not, as Sainsbury says, on the same day. 'Peaks and troughs are allowed to balance out to avoid price changes being passed on unnecessarily frequently,' says a spokesman for Nestle, which has 55 per cent of the instant market. 'But it depends on the duration of the fluctuation. We felt this latest move was so substantial we had to react.'

The bad news for the consumer is that last week's rise was triggered by the comparatively modest rise between the middle and end of last year. That means that last week's jump will not feed through until the autumn. 'We regard increases as inevitable, but the markets are so volatile we can't say how big they will be,' the spokesman says.

Another product where retail has closely tracked wholesale is salmon. Norwegian overproduction pushed the price of Atlantic salmon down from pounds 1.78 per pound last summer to pounds 1.25 in the New Year.

The European Commission then took action to shore prices up, and they have now risen above pounds 1.50. The price of salmon, as tracked by the Central Statistical Office, has followed these movements closely - the index dropped from 136 a year ago to 106 in December, then recovered.

The trouble is, the CSO uses prices for tinned red salmon - a Pacific product that bears no relation to its upmarket Atlantic cousin. Correlation can be just as confusing as the lack of it.

(Photographs and graphs omitted)