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Structured Commodity Financing: Are you familiar with it?

Posted by Markos Gkogkos
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Structured Finance

 

 

There is a number of ways a company can finance it’s business, either based on the balance sheet of the company or on the cash flow produced by the future transactions/utilization from its assets or the specific characteristics of an individual transaction. For different cash flow structures there are different ways to structure finance requirements for companies, amongst others:

 

  • Project Finance
  • Real Estate Finance (Retail)
  • Buy-out Finance
  • Structured Commodity and Trade Financing

 

Structured Commodity Financing

 

 

Structured Commodity Financing (SCF) is a financing technique to provide assistance in the trade flow of commodities.

 

SCF was specifically designed for commodity producers and trading companies doing business in the developing markets. Specifically, Structured Commodity Finance provides liquidity and mitigates counter-party risks for the actors in the origination, production, purchase and sale of raw, semi-fined or semi-processed commodities.

 

For example, let’s visualize how the trade flow of soft commodities should look like below:

 

 

 

Trade cycle of soft commodities

Trade cycle of soft commodities

 

 

 

Starting from the production stage and producers of the soft commodities to the traders, SCF supports the whole supply chain. Common element in Structured Commodity Finance is that there is an asset or a transaction facilitated, not a company or a balance sheet. There are some generic structure components in the financing arrangements, but the precise design of the financing varies with throughout the chain.

 

 

Key elements of Structured Commodity Finance

 

 

  • Commodity assets with a liquid character (short term\current assets) have a financing based on face value or on market value
  • Assets could comprise of contracts, stocks, guaranteed/secured pre payments, shipments, receivables, hedges etcetera
  • The assets serves as a collateral to provide the financier control (security) over the goods and cash flow
  • Sometimes a portfolio of assets is subject to a financing, thus not only the individual assets but also the portfolio serves as a collateral
  • Depending the structure of the arrangement, hedges allocated to the assets might be an un-separated part of the collateral to the financiers
  • The financier tracks the goods from procurement to sales and sometimes to receivable and/or collection (quantity, quality, location, movements)
  • The financier might assume (temporary) ownership for the goods it finances trough a sale/buy back arrangement (repo)

 

The unique value Structured Finance can bring to commodities

 

 

In industries like the commodity trade, where assets are continuously changing in terms of value and ownership and liquidation risk, SCF is a best practice financing solution.

 

Moreover, Structured Commodity Finance handles the complexity and risk of financing activities and transactions much better than the common trade finance (e.g. securing payments through letters of credit) or balance sheet based financing (leveraging equity). The asset based approach support the continuously changing locations and market values of assets and can survive ownership transfers.

 

Structure Commodity Financing can be embedded in buyers\supplier relationships, when such is initiated by one of the trading partners. You can think here in terms of vendor managed inventory or consignment stocks. Also financiers can finance specific buyer\supplier relationships and thus enable very specific forms of supply chain financing.

 

 

How to support Structured Commodity Finance ?

 

 

For an effective use of Structured Commodity Finance trade desks, logistic departments and finance departs need to work smoothly together to track and trace the composition of a commodity portfolio and the aligned financing arrangements. Tracking and Transparency on the moving components, such as quantities, qualities, asset classes, locations, counter-parties is required to leverage a structured commodity finance arrangement and to efficiently finance an asset portfolio.

 

As in commodity management itself, one should consider structuring its information management. Key success factor in efficiently financing a commodity business is to have the right information. A state of the art commodity trade and risk management software application will be a great help.

 

 

 

 

5 CTRM vs ERP system differences for commodity trade

Posted by Markos Gkogkos
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What is CTRM?

 

 

A lot of people confuse CTRM software with ERP technology. Of course there a lot of similarities and ERP technology is the bedrock of CTRM systems. However, CTRM is created to assist the daily specific functions in the complex world of commodity procurement and trade.

 

CTRM or Commodity Trade and Risk Management software is a dedicated software for commodity trading transactions and business processes. Its architecture, applications and functions should assist the daily work of all involved in a commodity trading company.

 

Meanwhile, it offers solutions to the traders and management to control and minimize the risks of the commodity trading activities and the business as a whole. CTRM is the software-pillar for all departments in a commodity company, like logistics, trading, finance, IT and the management.

 

With this core software, employees can perform their daily tasks and transactions accurately and efficiently and in the world of today CTRM is available through cloud solutions and on mobile devices.

 

 

CTRM is more than just an ERP system

 

CTRM VS ERP

 

It is common knowledge that ERP systems do not really cater for commodities companies’ needs. It is the character of the trading business that differs from standard wholesale and/or manufacturing business that creates the challenge. These differences we cannot just overcome by adding functionality to an ERP, it requires a fundamental different approach.

 

You simply can’t use the same pan to cook eggs, pasta or stew meat. Even if you manage to fit the stew inside an egg pan, you will not be able to cook it properly. Parts of it will be spilled out on the kitchen stove. So it works with the commodities businesses.

 

You simply can’t have your ERP system perform all your commodity functions, transactions and risk monitoring. Even if you attach 10 more “Add-ons” offered by the ERP supplier, still your “stew” will be spilling out of the pan while you are cooking it.

 

 

 

Differences ERP vs CTRM

 

 

1. Coping with versatility and variances

 

 

ERP software supports standardized wholesale, manufacturing and services environments. ERP supports these environments from a transactional perspective and integrates with accounting applications. Its architecture eliminates variance in processes to ensure adequate production processes, related transaction management and accounting processes. In the end most ERP’s reduce complexity and record transactions and value based on concepts like Bill of Materials or Work Break Down structures. ERP is usually centered about creating certainty and defining cost.

 

CTRM instead, does not reduce complexity, it enables companies to use complexity and with variance to their benefit. And this complexity and variance is intrinsic to commodity businesses. At the start the quality aspects of soft and agricultural commodities may vary during the lifetime of these commodities and form the basis for the spread in monetary values and risks in trading. Down the road, one trades commodities in different markets and different currencies under different terms and thus the monetary trading values differ in different environments as well. CTRM enables a company to manage these complexities and benefit from then, not just to eliminate them for process or accounting purposes. CTRM is usually centered about opportunity and value.

 

 

2. Facilitating hedging of trades

 

 

ERP applications mostly offer different application environments for different the activities impacting value. Interdependence between activities or variable value drivers are usually difficult to manage in ERP systems. For examples when a company is using dynamic price curves, trading or hedging strategies. In an ERP environment there are limitations in viewing and using combined data information from for example contracts, commodity hedges or currency swaps, and thus limits integral position management, valuation and forecasting.

 

A CTRM tool designed for commodity procurement or trading is based on long/short position management. CTRM enables companies to manage hedge portfolios either intrinsically or through the use of derivatives and/or swaps.  CTRM gives you freedom and agility in portfolio valuation and forecasting.

 

 

3. The variance in pricing

 

 

ERP systems are usually cost oriented and use fixed/cost prices to plan and project certain things. In commodity industries this approach is too restrained. It is the versatility and the variability in prices that matter and ERP applications have difficulty coping with that. For example capturing or using “to be fixed” pricing structures, or fluid logistic terms have proven to be difficult to manage for ERP systems.

 

CTRM systems solve these “issues” of future priced contracts or variable delivery terms. Commodity Trade and Risk Management systems cater for flexible volumes, prices and delivery dates without such restrictions of ERP systems. Since the orientation of CTRM is on value rather than on cost, it enables companies to make pricing decisions based on value rather than on cost.

 

 

4. The architecture

 

 

Most ERP software systems have a rather linear architecture, such reflecting the structure of the business they support. This means that they follow a certain line of functions and execute transaction according to their structure. Think, for example, a Work Break Down structure, a Bill of Material, a Recipe, or simply a departmental structure of a company. When you would picture such a structure you could imagine a pyramid of rectangular with linear association to each other from beginning to an end. Transactions and value development through the structure would follow a rather predefined and mostly sequential flow.

 

CTRM systems have a unique and far from linear architecture. The architecture needs to cope with the versatility and variance and needs to support creating value from it. One could envisage such as a combination of a diamond type of a structure combined with a spiral funnel. Even though we could observe an initial linearity, transactions and value development through the structure would follow an iterative and unpredicted or even paradox path. This is the essence of a CTRM! The architecture! The Architecture is the core of your system and has to be compatible to the characteristics of your business.

 

 

5. The risk management

 

 

The aforementioned limitations in the structure and capabilties of ERP systems prevent ERP in the most important need of the commodity trading business: managing value and risk. Commodity business have critical differences from wholesale or manufacturing or services businesses. They are just not so simple and straightforward!  Even within the commodity industries there are differences. The rules of the game, the terminology, contracts, calendars, trading methodologies are just different for different commodities. But also from company to company. So if an ERP cannot adequately capture transactions, cope with versatility and variance, and supports mainly linear processes, how can it adequately support commodity risk?

 

The functionality of CTRM software overcomes those difficulties in managing your commodity business. These ERP cannot perform efficiently due to its cost orientation and its linear architecture. Managing long/short positions, hedge portfolio’s, variable pricing, forward price curves and a value orientation is the ‘right to exist” for CTRM systems. For a commodity trading business or even a procurement business a CTRM with the right business fit is a prerequisite for short term performance and long term existence. When selecting a CTRM for your business, you better choose a CTRM system that supports the characteristics of the commodities you manage.

 

 

 

 

Sugar’s 6 influential price drivers

Posted by Markos Gkogkos
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Sugar is a soft commodity, which is produced, traded and consumed all around the world. The sugar cane or sugar beets are the raw materials from which farmers can produce sugar. We use sugar widely in everything from food to industrial applications. Sugar can be produced and/or refined many countries and finds its way in different forms, for different purposes to different destinations. For this reason sugar has a prominent position in the commodity trade environment and how sugar price affects trading procedures, is something which sugar traders need to know about.

 

Looking at the country origins of sugar as a raw material, the top producers of are Brazil, India, China, Thailand and Pakistan and the EU as a group. When you are thinking to trade sugar commodities the mayor things to consider besides the logistics chain are the price drivers of sugar itself.

 

Looking at just at sugar prices graphs is not enough to understand sugar markets, you need to take into account the factors that drive the sugar prices. So, which are the most critical price drivers for trading sugar commodities?

 

 

Sugar price drivers

 

1. Global sugar stocks (inventories)

 

This is a factor actually that affects all commodities. Likewise for sugar, low levels of stocks indicate strong demand, weak supply or a combination of the two. Because of the long supply cycle of sugar, whenever there is a problem in terms of storing the sugar commodities, then there is also a significant effect in sugar price.

 

sugar stocks worldwide

sugar stocks worldwide

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2. Inflation of US dollar

 

US dollar is the main currency, which people use in financial transactions. This actually is the same for most of the commodities and especially for sugar as sugar derivatives are priced in dollars both in London and New York. A decrease in the value of US dollar relative to a commodity buyer’s currency can cause headache to the finance counselors of trading companies. Why? Because in this way the one who buys should spend less of their own currency for a certain amount of the commodity. A less expensive commodity is the reason for an increase in the demand and as well in the price.

 

 

3. Oil price

 

Another important factor which influences the price of sugar is oil price. This is because sugar can be considered an energy source. The value of an energy source depends on the caloric value of the source and the energy price. The latter is dominated by the oil price. This is not theory; in practice the sugar cane farmers in Brazil can produce sugar or ethanol from their cane. The ethanol, competes with gasoline in the transport fuel market. Thus a decrease in gasoline’s price will also mean a decrease in ethanol prices and hence less demand on sugar cane to produce ethanol, thus potentially an oversupply of raw sugar. And an abundance of raw sugar wil bring sugar prices down.

 

 

4. Weather conditions

 

As mentioned before countries with warm climate produce sugar mainly. However, imagine that a warm climate can also be “too warm” for sugar. A drought in Brazil, for example, can damage sugar canes and make the production cycle roll slower. While too warm atmosphere can cause problems, also wet weather is not ideal for producing sugar. Sugar canes require dry atmosphere. Malfunctions in the production cycle due to weather conditions are another driving factor in sugar price.

 

 

5. Governmental regulations

 

Governmental contributions and import tariffs are playing also a role in the game of sugar trading. Governments have twisted the sugar markets and the result is the excessive production of sugar cane. Europe today is the second larger sugar exporter in the world. In US though, import tariffs are meant to protect domestic farmers, so prices for US consumers have been raised. This is also why US consumers now are looking for different types of sweeteners.

 

 

6. Consumption trends

 

Most of us like sugar. Sugar is everywhere it provides us physical energy and makes food taste good. As the world population is growing the sugar consumption is most likely to grow. But sugar is also responsible for various health concerns such as obesity, diabetes and dental health. Governments and institutions have started educating consumers and as a result consumers are becoming more aware of the health aspects of sugar. Since the trends for healthier nutrition gets more momentum in the mature sugar markets, this could possibly slow down the growth in sugar demand in the future.

 

 

Control your price risks

 

 

The commodity price volatility and price trends are the first thing that traders and financial managers are monitoring in their daily operations and risk management. The second is the exposure they have to these markets as a result of their contracts, price & margin strategies and no to forget their cash flow projections. In addition a large scale of hedging instruments is available such at Futures, Options and OTC where in sugar specific mechanisms play a role such as “white premium” and “polarization premium”. These are complex processes due to the variety of variables and their dependencies and correlations.

 

A good way to manage price and margin risks of a sugar business starts with implementing the right technology to support it. A general ERP system is mostly not the right tool for managing a commodity business. We advise to choose an application specific to your sugar trading businesses, and when in trading of managing price risks with futures contracts, select CTRM software made for sugar trading.