Example of commodity trade in real life - Sri Lanka and Vitol. Accurate?
So the one thing I've been noticing in commodities trading posts is that while there are a few posters that go into relatively deep detail, there's never really a clear example of a trade. From my understanding with the whole Sri Lanka situation and Vitol supplying gas, is this how the trade could be structured (yes i know commodities are a secretive world, no need to spill all the beans).
Wanted to know if this is how the process roughly works. So if this is completely wrong, call me out on it.
Sri Lanka PM gets his energy department staff to call up oil traidng houses (Glencore, Vitol, Trafigura, etc).
Geneva/London/Houston traders at these firms compete to put best price. Some Vitol guy in Houston "wins" the contract. For simplicity, Sri Lanka is requesting 100 gallons of gasoline and Vitol guy is willing to sell it at $2 after buying it for $1 from a Texan oil company.
Now the Vitol guy will work with Sri Lankans to manage the intricacies of shipping it out from Texas (just one example of an oil location) to Sri Lanka. While being shipped out, the Vitol guy shorts gasoline futures as a hedge.
Once gas arrives at a Sri Lanka harbor, gov pays Vitol and gas is unloaded.
you forgot the bribery & prozzers for the Sri Lankan cabinet!
FCPA is a real buzz kill for the yanks. There's a reason they are all in Switz and not just for taxes
Yeah, those are the basics.
Another example with a little more detail.
It is currently June and a Japanese buyer wants hard red spring wheat delivered in October. Him and I agree that I will deliver it at $22/bushel(bu) to a port in Japan. In this example, let's pretend futures are at $13/bu, basis in Portland is +$4/bu, and freight to get wheat from Portland to Tokyo is $4/bu. So that means right now I can buy physical bushels in Portland and have them delivered to Japan for $21/bu. If I locked in everything right now (back to backed it) I could make $1/bu in profit. But what if I actually want to do some trading and take a view on the market?
Based on what is going on in the market I decide that I am going to wait to buy to the wheat because I think I can get a cheaper price in Portland once harvest gets rolling. I also decide to wait to book the freight because I think I can get a cheaper price later. At this point I have risk in futures, basis, and freight. I don't have a view on what futures are doing so I decide to hedge that risk by buying futures. What exact futures I will end up buying is dependent on my view of the forward curve (what goes into this decision is worth it's own post). At this point I don't care what the flat price of futures do. All I care about now is the local price of wheat in Portland and what freight is going to cost to get over there.
Fast forward two months or so and it is now September. Turns out that the spring wheat crop got timely rains and yields are looking great. There is tons of high quality spring wheat out there and basis in Portland has fallen to $3/bu. Freight has gotten cheaper as well due to falling worldwide bunker fuel prices and I can now get a boat to take wheat from Portland to Tokyo for $3.75/bu. I decide to lock in those prices by buying wheat from an elevator in Portland and booking the boat. Once I buy this wheat from the elevator in Portland I will sell the futures I previously bought. Any losses on the hedge will be offset by a lower cash price in Portland. Any gains on the hedge will be offset by a higher cash price in Portland.
My delivered costs to Japan are now $13(futures) + $3(basis) + $3.75(freight) = $19.75 delivered Tokyo. 22 - 19.75 = $2.25/bu of profit and now you can buy some imported udon noodles at Whole Foods for $50/pound.
thanks Rotterdam for the detailed trade. Could you shed some light on how a trader at one of the big houses would get a relationship like in the hypothetical scenario with the Japanese buyer? Do they rely on existing relationships or are traders expected to be always trying to find new partners? Or is it more of a combination of those two? I'd always imagined it as a "meritocracy" in the sense that you're basically on your own to find the buyers and be a smart trader (like the decision of waiting it out in your scenario).
Totally depends. How does a drug dealer meet his buyers? New business is always good but that doesn't mean it's every shops number one goal on all desks. Certain desks might get tapped out on volume (don't need any new demand if you can't source any more supply) so there aren't really any new trading partners to find. Some desks might be looking for new buyers as their number one goal and the traders job is more deal origination oriented.
For example, maybe you just earned your first trading seat after years as an operator at a trade shop. In that case, you're most likely going to inherit some buyers that you met from your time as an operator on that desk. In another case, maybe you are at a big conference type event and end up meeting someone you hit it off with and he starts using you to source his copper. That guy that is now buying copper from you most likely knows someone else that buys a lot of copper. You do a good job with him and you could easily end up landing his buddy as a buyer as well.
A good example of someone I know that buys a lot of resin... you know who he buys from? A guy he went to high school with because they ran into one another at the grocery store one day.
I know you probably just used this as an illustrative example and didn't want to delve into the details, but do you tend to work with entities (source/buyers) where fixation terms (for futures hedging) are not arranged ahead of time? This is coming from someone whose product tends to be hedged nearly completely at seller's/buyer's call and thus basically never has any room to play with futures, so quite curious.
Not my example, but I can try and chime in:
In September. when Rotterdam goes to actually purchase his HRS from the elevator in Portland they will agree upon a basis price off a the respective futures month, so in this case it will probably be +300Z, $3 over the Minneapolis hard red spring wheat December futures price. One can assume that the elevator would use the December futures month for this elevator as it will be the nearby futures month. but Rotterdam could trade the spreads around the futures month especially because he wants to hedge months before he locks in basis.
Lets say Rotterdam thinks that JFM will be an extra hot time for PNW exports of wheat, then the market needs to incentivize the elevators to carry grain past the December price. Rotterdam would then want to hedge with a March HRS futures contract and would be bear spread the market as the position is now short October grain which will be referenced off the December futures when basis is set with the elevator, and long the March. When Rotterdam puts the trade on in July lets say the Z/H spread is trading at -$.03, but by the time September rolls around and the basis is locked in with the elevator, the spread gets blown out to -$.28. His March contract which he bought only $.03 above the December price is now worth $.28 above the December price, so when Rotterdam sells his March hedge to buy October grain, nets $.25 profit on the spreads. Bringing the total profit to $2.50
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