Raw materials are bought and sold at all times around the world – from common consumer sales at the corner shop to billion-dollar obscure transactions. Commodity trading occurs naturally, without much public attention – except in cases of price spikes or some environmental scandals. This article is an introductory text to the world of commodity trading.
What is commodity trading?
To many, commodities are an elusive concept. CTG will break it down into digestible pieces. Find below an introduction to the main topics about commodities.
Commodity trading – what are we talking about?
Commodity trading generally refers to the international trade of raw materials for industrial use, generally in large quantities and in bulk. The concept originated centuries ago in different trading hubs around the world. Currently, the concept involves an additional layer of risk-management using financial instruments such as derivates.
Some commodity markets such as crude oil or basic food crops are generally deemed strategically important and have deep geopolitical implications as they might define foreign policy.
Physical trading and paper trading; what does it mean?
Commodities are physical products, hence the notion of physical trading, which refers to the actual buying and selling of physical raw materials including delivery.
Paper trading, on the other side, refers to commodities (and other assets) that are traded on paper only, using derivative products such as forwards, and future. In other words, paper trading refers to transactions where the physical goods are bought or sold “on paper”, using contracts where the underlying asset is based on a commodity (or other assets). Commodity markets participants use a number of trading instruments to control risk, and paper trading is one of them. You’ll find more information in other sections.
Why do commodity markets exist? Well, producers, consumers, and traders buy and sell commodities for different reasons, and with different objectives. On the one side, producers want to sell their products at the maximum price possible, on the other side, consumers want buy their supply at the cheapest price possible. Traders want to buy cheap and sell a tad more expensive. They all want to make or save money with their transactions.
All parties want to protect their interests and monitor risks associated with the price of the commodity. In this sense, parties might agree today to sell/buy a cargo at a price and conditions fixed today, but to be delivered only months or years later. These contracts are called forward contracts.
Derivative contracts come in a variety of shapes and forms and not only apply to commodities. Physical or cash markets mostly refer to forwards contracts. Exchange traded futures or OTC deals are referred to as paper markets.
One example of a :
Cash/Physical trades: Eni sells Shell 30,000 MT of gasoil to be delivered in May 2017 at say 450USD/MT.