Dalian LLDPE futures explained?

My last blog entry quoted a North American industry source who was concerned over the potential for physical delivery on the Dalian futures exchange to flood the real market and send prices crashing.

In my ignorance of how futures markets works, and as a typicaql semi-numerate journalist, I therefore asked a colleague with a futures/mathematical bent to help out. This will hopefully allay the above fear.

Here is his explanation (please feel free, as always, to disagree):

If you look at the English part of the website you’ll see that several months before a contract expires (.e.g. in April for July delivery) there is an enormous amount of open interest (the dating system is confusing as each contract starts with 10 after which it makes sense).

This huge volume of open interest mainly involves financial speculators who have no intention of either acquiring or taking delivery of physical material.

They will agree in advance to cash settle before the expiry of the contract and so you if then look at a few days before a particular contract closes the open interest declines dramatically as once a contract does close and no cash settlement takes place, physical delivery has to take place. This helps to explain the very small delivered volumes also reported on the site.

See an Insight piece from my colleague Becky Zhang in our Shanghai office -. It seems as if the producers and buyers are not using the market in a big way to hedge; it’s more the speculators trying to make lots of good money.

This raises an interesting separate point on the debate over whether there are large volumes of physical polyolefins in inventory.

Why would a lot of people bother renting a warehouse, taking delivery and taking all the risks associated with this when you can just go on the exchange and make money out of purely paper trading?

The other good thing about Dalian, as I understand it, is that you can get your money out straightaway – and with such incredible volatility on a daily basis you stand to make (or lose) money very quickly. This a lot quicker return than waiting to close a physical position.

This still leaves the longer-term issue of whether the market could become a de facto pricing influence. This could happen either because people believe it’s important (to use another cliché again a self-fulfilling prophesy) or if the big producers and buyers start using it in a big way to hedge.

This is all work in progress so I will keep asking.

The above also doesn’t explain why LLDPE demand has apparently remained resilient in the physical market, even though this is not an agricultural film-buying season.

I am also still working on the issue of the influence of availability of imports of recycled polyolefins.

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