17 September 2008 19:11 [Source: ICB]
Taking the heat for commodity price inflation, traders have been given a bad rap. But do speculators actually play a vital role in industry?
SINCE LAST year's European Petrochemical Association (EPCA) meeting, crude oil prices have hit $100/bbl before rocketing to a high of $147.50/bbl, and then gone back below $100/bbl. The news made front-page headlines across the globe, together with speculation and analysis of the causes of the volatility.
One of the more interesting things to come out of the record-high oil prices was the dawning realization on the part of the mainstream media and the public that oil prices - the fuel for their cars, the source of their heating and electricity bills - were the product of traded markets.
Regardless of supply and demand fundamentals, traders, characterized as slick, champagne-swilling BMW drivers with their eyes on nothing more than the bottom line and their secretaries' bottoms, copped the blame. The word "trader" became synonymous with risk-taking excess.
"Speculation!" screamed tabloids and broadsheets alike. In the US, the Washington Post reported: "A Few Speculators Dominate Vast Market for Oil Trading."
The paper cited the US Commodity Futures Trading Commission (CFTC) as saying that "financial firms speculating for their clients or for themselves account for about 81% of the oil contracts on NYMEX [the New York Mercantile Exchange]."
The CFTC reported that a single trading organization had held as many as 11% of all NYMEX crude oil contracts at one point in July, doing little to help the image of commodity traders.
JAIL NO LONGER JUST SPECULATION
Last month, two former natural gas traders in the US were jailed for 28 and 57 months, respectively, on eight counts of fraud. The two, formerly of El Paso and Dynegy, had reported false gas prices to pricing intelligence services.
It would be easy to assume that under these circumstances, the petrochemical industry itself would begin to look at its own traders with more than a modicum of suspicion.
Yet, as the line between the classic definitions of "industry" and "trade" is increasingly blurred, with major producers and consumers employing their own traders to optimize their spot coverage, it seems that the role of the trader has never been more essential or more accepted.
"For me, the word 'industry' is all-encompassing," says Ashok Kishore, an elder statesman of the petrochemical trading business, and miles away in his office in Zurich, Switzerland, from the image of the typical London city boy or Wall Street trader.
SERVING A LEGITIMATE PURPOSE
"We [traders] are part of industry. We are no less industry than a producer or consumer when we buy or sell products," says Kishore, a trader for Trammochem, the trading arm of US-based Transammonia. "We do work alongside producers and consumers. We provide a service in financing, in storage, in transportation. When we say we will buy September and sell October, we are offering a financial service," he says, by bridging the time requirements of the customer.
A source at a major European styrene and polystyrene (PS) producer says: "We see two categories of trader: the ones we do our business with are those who have something to offer in terms of infrastructure, such as tanking, rather than buying from A to sell to B. If players have tanking in Rotterdam and are prepared to break it down, selling in the truck market, then that really adds something for us."
The other side of the equation, he says, are those traders who profit solely from speculating - buying and selling "without ever seeing the physical volume." These, however, are increasingly rare, he adds, a sentiment echoed by Kishore.
Paul Hodges, chairman of UK-based consultancy International eChem, says: "The original role of the trader was that they profited from volatility. They would make moves on peaks and troughs. When the volatility died away, they moved into a service-based industry and took on tanks that were too expensive for industry to run. The volatility has come back, they have the infrastructure and some of them have been around for a while, so some of the industry guys who have only come into the industry in the last two or three years have these people to mentor them."
The return of the spot market peak and the trough is evident in the petrochemical complex, with crude oil adding a punishing volatility to daily operations, especially in further upstream markets such as aromatics.
"This volatility helps no-one," says one benzene trader. "It kills downstream demand, and makes working spot volumes more risky, which kills liquidity."
In the European benzene spot market, August alone saw deals at highs of $1,420/tonne CIF (cost, insurance and freight) ARA (Amsterdam, Rotterdam, Antwerp) and lows of $1,160/tonne CIF ARA, a rather impressive spread of $230/tonne, according to global market intelligence service ICIS pricing.
A year earlier, the month of August had seen a trading range of $980-1,060/tonne CIF ARA, an $80/tonne spread. A year later, the market was trading up and down $70/tonne plus in a day.
The question of speculation raises its ugly head here, with a number of industry sources saying that this kind of volatility made no sense and was the fault of those market speculators.
But, says Hodges, the role of traders in markets is to smooth out curves rather than to turn the market into a roller-coaster ride from which only they benefit. "It creates more short-term volatility but smooths things out in the long term," he explains.
Speculators have an important role in bringing the market in line with realistic valuations, by buying or selling when the market becomes overheated or undervalued, explains another trader. Their actions might lead to short-term volatility, but a long-term smoothing of the price curve. It is important to remember, says Hodges, that the speculators take the risk.
And in times of supply length or shortage, which can also add to volatile prices, it is the trader again who takes the risk, says Kishore.
BENEFITING FROM SPECULATION
"When I started out as a trader, I learned that the classical definition of a trader's job was to move product from times of surplus to times of deficit and from areas of surplus to areas of deficit," he says. "We continue to provide that service."
Again, industry sources agree. "When we saw the Asian arbitration open earlier in the month [August], it was a couple of producers and a couple of traders who had infrastructure who exploited it," says the styrene and PS producer. "We all benefited from that availability, and those traders helped make it happen."
Daily trading also adds liquidity and makes markets more transparent, says Hodges, and a major plus of a transparent spot market is an added flow of information.
While working for UK-based coatings manufacturer ICI, Hodges had been part of the company's original trading team in the US. "It was an eye-opening experience for us when we stopped concentrating on our balances and started looking at what everyone else was doing," he says.
In a report titled: Energy prices, fuel poverty and Ofgem, a UK House of Commons select committee this year found that it was not speculative trading that was an issue in energy markets but a lack of liquidity in gas-trading hubs (see page 34).
"[The committee] concluded that creating greater liquidity in Europe's gas trading hubs would increase confidence in price formation, and help break the oil-gas price link," the report stated.
But regardless of spot trading, said Malcolm Wicks, UK Minister of State for Energy, "the era of cheap energy is over." More transparent trading would, at the very least, allow for easier analysis of the rationale behind market movements.
"Traders set base prices," says a former industry source. "They ultimately dictate market prices. But they also put more products on the market, increase liquidity, decrease volatility, work arbitrage, and provide the finance and risk management necessary."
It is also important to remember, says Hodges, that industry both feeds and benefits from trade. "It's industry that keeps the traders in business. The real question I would ask myself would be: 'What benefit is there if you go through traders?' If you find yourself doing a lot of business through traders, it begs the question: 'What are they doing that you are not?'"
Peter Salisbury is the ICIS pricing editor for benzene, styrene, toluene, ethylbenzene and cyclohexane. He has been working for ICIS since April 2007, following a varied career that in teaching in Cuba, bartending in Spain and researching James Joyce in Zurich, Switzerland.
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