Will industry let LME plastics futures take the strain?

27 May 2005 17:55  [Source: ICIS news]

LONDON (CI)--The London Metal Exchange (LME) has met its first plastics deadline with the launch Friday of open and electronic trading of futures contracts for polypropylene (PP) and linear low density polyethylene (lldPE). It will use the summer months to bed the contracts in and ensure that information technology (IT) and clearing systems work efficiently. By the start of Q3 its warehouse systems will be expected to be running to order.


Only then will market makers and players be able to gauge where interest in these new risk management tools in chemicals might lie and how great that interest is (potentially at least). Protagonists of the exchange’s launch suggest that it will take until around September 2007 to really build liquidity in open plastics futures trading. By then conservative estimates point to a level of trade of about 1000 lots of 25 tonne (24.7 tonne to be exact) a day.


The LME and its ring members will be pushing further to attract converters and downstream plastics users on to the exchange to hedge their plastics risk. Producers may take a little more persuading but they will eventually take part.


Neither traders nor the exchange want fools to rush in (or rather clients to rush in to make fools of themselves). On the other hand they have their eyes firmly on a plastics chain the movers and shakers in which have a great deal of financial risk they could offset.


The LME’s initiative will prove whether the time has come, at long last, for more sophisticated and transparent risk management in chemicals. Many have tried, usually half-heartedly – and failed – to introduce a variety of risk management tools into the sector. It is, of course, possible to establish limited OTC (over the counter) type hedging mechanisms with a third party. The LME is the first major exchange though to take a chance on plastics. It firmly believes that the plastics chain from producer to end user is similar to non-ferrous metals. The exchange is the largest global non-ferrous metals market so it should know what it is talking about.


Bringing such broad experience to bear will eventually have an impact in plastics and lead to fundamental changes to current market and price setting mechanisms. But the critical point is that only time will and indeed can tell. Players in the plastics chain, whether from the plastics producing industry itself or from further down the customer chain, will have to want to trade these risk management vehicles. If the industry does not want greater market transparency it will not seek it.


I have noted before in Insight this year that petrochemical companies persist in allowing complex and damaging price mechanisms to proliferate ultimately to their detriment. The underlying problem in European polyolefins particularly is that risk is not being managed across the system running from feedstock to converter. Companies are so keen to pass prices on that they do not fully appreciate that change might bring about longer term benefit.


Inefficient pricing drives inefficient production and helps value leak from the system. The underlying risk in the value chain has been to translate real-time pricing upstream into firm annual pricing downstream.


The LME polymer contracts at least provide a clear tool through which some of this risk might be managed. Whether producers and others recognise this, however, is another matter.


In the run-up to the LME plastics contracts launch the focus has been very much on treasury management and others more closely associated with futures and options trading. The key challenge for the LME and its supporters, and indeed for the industry as a whole, is to develop a deeper understanding of risk management not just up but well down the chain of command.

By: Nigel Davis
+44 20 8652 3214

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