The price of a product is a key factor in determining the profitability of producing and using it. And a transparent pricing structure encourages liquidity, which enables price discovery to take place more easily between buyers and sellers. This is why I have long been a supporter of the London Metals Exchange (LME) initiative to trade futures contracts in PP and LLDPE.
At the moment, pricing in the cracker and thermoplastic sector involves a long chain of players, many of whom have differing agendas and priorities. The actual producers and users of the products rarely get to negotiate prices directly with each other. Instead, the main buy-sell relationship today is often with a converter. As a result, much pricing is done on a lagged basis, so the ultimate sales price is often not known until well after the product has left the factory gate.
This ‘lag’ also creates an opportunity for playing the market. Converters, for example, can build stock if they see feedstock prices rising, and reduce it when prices fall again. But this is not a zero-sum game, as cracker operators and polymer producers then have to respond by adjusting operating rates up or down (always very expensive). Equally, unnecessary polymer imports and exports take place, as players down the chain respond to confusing signals about demand trends.
This is why I was glad to see in the MF Global daily plastics report this week that some players, at least, are now starting to hedge LLDPE and PP by using a monthly average price based on the LME prices. This is only a small step forward, but anything that makes it easier for producers and consumers to better manage their business is to be warmly welcomed.
Hopefully it will also encourage others to experiment with LME trading. As the downturn edges ever nearer, it will become increasingly vital to have an accurate picture of underlying demand. Today’s lack of transparency and liquidity in pricing will otherwise extract a major cost in terms of lower profitability throughout the value chain.