Commodities : International Environment & Trading (OFIN 2290A)

1. Commodities : International Environment & Trading (OFIN 2290A) Franck Pradier – Commodities Derivatives Trading– February 2008 1 –International Commodities Trading

2. History of Commodities Classical civilizations built complex global markets trading gold or silver for spices, cloth, wood and weapons, most of which had standards of quality and timeliness. The modern commodity markets have their roots in the trading of agricultural products. While wheat and corn, cattle and pigs, were widely traded using standard instruments in the 19th century in the United States, other basic foodstuffs such as soybeans were only added quite recently in most markets. For a commodity market to be established there must be very broad consensus on the variations in the product that make it acceptable for one purpose or another. The economic impact of the development of commodity markets is hard to over-estimate. Through the 19th century "the exchanges became effective spokesmen for, and innovators of, improvements in transportation, warehousing, and financing, which paved the way to expanded interstate and international trade.“ Commodity exchanges began in the middle of the 19th century, when businessmen began organizing market forums to make buying and selling of commodities easier. These marketplaces provided a place for buyers and sellers to set the quality, standards, and establish rules of business. By the late 1800s about 1,600 marketplaces had sprung up at ports and railroad stations. The London Metal Market and Exchange Company was founded in 1877 but the market traces its origins back to 1571 and the opening of the Royal Exchange. At first only copper was traded, lead and zinc were soon added but only gained official trading status in 1920. The Chicago Board of Trade was founded in 1848. The NYBOT in 1870. The NYMEX in 1882. The COMEX in 1933.

3. Commodities World Map Canada:Oil, NG (7%), Gold, Silver, Lumber Russia:Oil (11%), NG (22%), Gold (7%), Silver, Alu, Nickel China:Oil, Coal (42%), Ethanol, Gold, Silver, Base Metals, Steel, Corn, Cotton, Soybean, Wheat US:Oil, NG (19%), Coal (20%), Ethanol (35%), Gold Silver, Alu, Copper, Lead, Wheat, Corn (41%), Cotton, Soybean (38%), Sugar India:Coal, Ethanol, Alu, Cotton, Wheat Saudi Arabia: Oil (12%), NG (3%) Australia:Oil, Coal, Gold (10%), Silver, Alu, Copper, Lead, Nickel Brazil:Oil, Ethanol (35%), Alu, Coffee, Soybean, Sugar South Africa:Oil, Coal, Gold (12%), Platinum (78%)

4. Key facts 1. Physical Commodity trading represents around : Where: Crude Oil $3 120 Bil Refined Products $3 600 Bil Electricity $1 000 Bil Natural Gas $ 800 Bil Coal $ 700 Bil Emissions Eur 48 Bil Wheat $ 50 Bil Cotton $ 20 Bil Sugar $ 40 Bil Aluminium $ 101 Bil Copper $ 132 Bil Zinc $ 28 Bil Steel $ 700 Bil Gold $ 82 Bil Silver $ 13 Bil Commodities Derivatives Trading represents in comparison : $ 300 Bil turnover /day 2. Commodities markets have some intrinsic characteristics: High Volatilities & Spikes Long term trends Seasonality High speculation Physical delivery Very sensitive to International Politics Price not all the time driven by fundamentals like production, stocks… Each commodity markets have their own regulation & standards Energy Commodities have a strong interrelationship together

5. Trends & Cycles

6. Trends & Cycles

7. Trends & Fundamentals

8. Interrelationships within the energy market Power Coal LPG Gas Emissions Crude Oil Oil Products BioFuels Refining Margin

9. Crude Oil West Texas Intermediate $/bbl +210% in 15 months

10. US Gasoline RBOB +185% in 15 months

11. Coal API2 +320% in 26 months

12. Gold Spot +350% in 6 years & +150% in 8 months

13. Corn +250% in 16 months

14. Soybean +300% in 15 months

15. Wheat +416% in 15 months

16. Base Metals Price of H.G. Aluminium relative to other base metals Nickel Zinc Jan 2003 Price = 100 Copper Aluminium

17. Functioning of Physical Markets • Physical markets are OTC markets where producers sell commodities to physical traders or other producers. • They need to take care of Freight & Insurance (FOB – Free on Board vs CIF) but can pay for them. • Practically there is plenty of different qualities for each commodities : • for Crude Oil: 6 for North Sea, 11 in US, 7 in Canada, 12 for the OPEC basket. A total of more than 100 different quality of crude oil is traded across the world. • for refined products: in Europe there is 50 different products available – each can be FOB or CIF. Worldwide that is maybe 200. • The spot price assessment is a method defined by an external organisation (Platts, ) to fix a closing price of a commodity each day. They define that as “the latest range in which a standard repeatable transaction takes place or could take place at arms length”.

18. Functioning of Derivatives Markets The Commodity derivatives markets were set up to enable commodity actors to hedge their future consumption or production in order to be able to smooth their future profits or costs. After few years speculators used these markets to punt aggressively. Each market disposes of a Forward curve: for each standard maturity you can enter into a forward agreement (Buy or sell). This forward curve represents the perception of the supply-demand at each expiry date. Ex: for Crude Oil WTI you can trade each monthly expiry up to 36 months + all the 4 next december contracts Exchange traded Futures or OTC Forwards & options are available for market participants. The listed Exchanges trade 22 hours a day. The settlements are defined as the average price during a short period (1 to 5 mns).

19. Actors 1 - Physical Players: They are generally producers or work like financial intermediaries. They are trying to optimize the fixing price of a commodities each day, week, month and to take profit from their size. For oil & Gas: The Majors (Exxon, BP, Shell, Total, ConocoPhilips, Repsol) & the Russians (Gazprom, Lukoil), Hess & Mitsui For Electricity: RWE, EDF, Eon, Vattenfall, Enel, Endesa For Metals: Arcelor-Mittal, BHP Bilington For Agricultural products: Cargill The Commodity Traders: Glencore, Vitol, Trafigura, Mercuria, Gunvor, Phibro, Sempra 2 - Speculative Traders: They are generally Hedge Funds or Bank traders who are trying to make profit on a short/mid term positions. 3 - Investors: A new trend in commodities market: Commodities Assets are considered as Investments. The Asset Managers are investing some very large slice of their capital to protect the rest of their portfolio against Inflation. 4 - End Users: Industrial Corporations or Airliners face to a risk of commodity prices. They need to forecast prices evolution and to hedge against these risks.

20. Commodities Crisis? Recession in US: Impact on Global growth and Global commodities demand? Credit & Subprime crisis: Impact on Financing?? Banks crisis: Impact on Investment?? Euro/Dollar & Equities crisis: Impact on Commodities prices?