The Physical Challenge
Global commodity markets are undergoing a period of unprecedented change, with some bumper times in recent years fuelled by buoyant demand for raw materials from rapidly developing markets, especially China. This sustained rise in prices is sparking the interest of bullish investors seeking to sidestep the diminishing margins and falling returns of some other asset classes. But the unique challenges of trading physical commodities have placed new demands on existing systems and expertise. Stuart Cook & Richard Philcox identify the difficulties and explore the possible approaches.
BANKS AND COMMODITY trading houses have been long-standing investors in ‘paper’ commodities. But it is against this backdrop that they (along with energy and utility companies) are increasingly starting to turn to physical commodities such as coal, oil, freight and liquid natural gas (LNG) as a lucrative opportunity to diversify their portfolios and increase revenues.
illustrated all too well the perils of falling foul of a volatile market, driving a fresh emphasis on risk management as a core part of organisational strategy for all firms trading in the commodity sector.
Inadequate Systems Handicap In many ways, the fundamentals of trading in physical commodities are similar to those of their financial counterparts, but there are some significant differences when it comes to the degree of complexity. Indeed, the very fact of physical delivery creates a whole new set of implications and challenges, especially given the fact that physical supply chain management brings with it complex optimisation problems – something recognised but not always fully understood in the financial world. The institutions considering testing the waters in the physical markets are therefore beginning to realise that there is a significant gap both in their systems and expertise. This leaves them managing diversified portfolios with one hand tied behind their backs.
Traditionally, many organisations have
relied heavily on resource-intensive, paper- based processes to manage their critical information flows for physical commodities. When combined with a barrage of systems, these error-prone processes often led to requests arriving in disparate formats, with the resulting action involving multiple steps across different departments.
... the unique challenges of trading physical commodities have placed new demands on existing systems and expertise
But this is a highly volatile market.
Of course this volatility could put early movers who call the market correctly in line for some stellar returns. At the same time, recent high-profile corporate failures have
58 December 2010
Better Visibility on Processes Throughout Lifecycle The complexities of trading physical commodities make it more important than ever that companies have full visibility and
integration throughout the supply lifecycle. And that visibility into key business processes across the front, middle and back offices depends on access to accurate and real-time views of each stage of the physical commodities process from demand analysis to delivery of the commodity. Take the case of physical oil. Purchasing the oil itself is just
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