Platinum, a key input to critical refining catalysts, has already faced steep multi-year price declines and has recently hit a long-term low. However, recent hints at a price rebound point to substantial possible cost risks for downstream firms.
Summary: What Happened?
In late March China launched its first oil futures contract that may fully appeal to non-Chinese risk managers. Since oil field service (OFS) providers and other companies often peg contract pricing to oil benchmarks such as WTI and Brent, this introduces a new option for contracts. However, O&G supply chain teams should beware the new option: rather than entertaining the new Chinese oil futures, teams should consider less risky and more established alternatives to mitigate risk and avoid unnecessary costs.
Why Have I Not Heard of Chinese Futures Before Now?
Despite surging activity on China’s three main commodity exchanges (the Dalian Commodity Exchange, the Shanghai Futures Exchange, and the Zhengzhou Commodity Exchange), until recently, several factors have precluded Chinese commodity futures markets from emerging as commonly referenced international price benchmarks:
- Lack of cross border access: Foreigners have seldom been permitted to access and utilize Chinese commodity futures. Only a limited number of Chinese state-controlled enterprises have been granted licenses by the Chinese government to transact in commodity derivatives outside China.
- Non-convertibility of the RMB: The Chinese government limits the convertibility of its currency, the RMB. This can make exchange rate transactions costlier to execute than those with other currencies. Market participants have expressed concerns that profits earned on Chinese commodity futures contracts may potentially be difficult to move out of China.
Both factors have contributed to large divergences between Chinese and foreign benchmark pricing across many commodities. These divergences make Chinese contracts unsuitable to hedge commodity exposure incurred outside of China and arguably make Chinese commodity derivative prices less reflective of global market conditions than their foreign equivalents. Traders and supply chain managers have thus been reluctant to use them.
Last fall, renewed optimism resounded across oil markets. The North American rig count had fallen by almost 50% since January of 2016 and was a tiny fraction of where it stood prior to the oil price decline that began in mid-2014, foreshadowing weak supply growth. Moreover, the Organization of the Petroleum Exporting Countries (OPEC) appeared to finally be ready to take advantage of these lower levels of shale activity by cutting output and paving the way to a recovery in oil prices. North American oil prices jumped jubilantly when this action came to fruition and OPEC signed a major deal in which members agreed to curtail production.
Figure 1: A Brief Oil Market Deficit and the OPEC Deal
Sources: US Energy Information Administration (EIA); PowerAdvocate Energy Intelligence Group
Steel is the largest metallic cost driver in energy supply chains. As such, its volatility over 2016 has led supply chain teams to look for ways to manage this cost and mitigate the potential impact of further large increases in the price of steel.
In contrast to base metals like copper, aluminum, and nickel, which have deep and liquid financial derivatives markets, steel production and consumption is fragmented amongst differing grades. This has inhibited the development of a robust hedging market for steel.
Indeed, volume and open interest in exchange-listed steel contracts looks miniscule relative to major base metals benchmarks. While steel is admittedly a relatively expensive and difficult commodity to hedge, this post examines the cost and efficacy of options available to American firms wishing to mitigate their steel exposures.
As oil prices began falling in mid-2014, oil market observers naturally assumed that OPEC would play its traditional role and cut production in order to stabilize prices. However, since then, the group has failed to implement any meaningful cuts, contributing to a massive global supply glut and a bear market in crude. While this course of action is partially a response to the economics of US shale plays, it has been driven by internal clashes within OPEC, particularly between Saudi Arabia and Iran.