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Physical Commodity Trading

vanquan's picture
Rank: Senior Chimp | 19

Hi,

Can someone explain how exactly a physical commodity trading house makes money and why there is a need for independent comodty houses, whats there right to exist?

What are the risk when trading commodities physical and how can they be hedged, are there specific hedging strategies that are applied by physical traders?

physical commodities trading overview

Physical commodities trading is a business that exploits the arbitrage that exists when selling oil (or any commodity) for physical delivery in different markets or at different times. Our users explain below.

Gekko21:

Physical Commodity houses make money by trading commodities that actually exist. Even though a futures contract is physically deliverable, most positions are closed out before physical delivery needs to be made. They are not just trading a piece of paper that is worth 1,000 barrels. They literally trade barges of oil or oil in a pipeline that NEEDS to go somewhere.

There are a few risks for physical commodity prices, but the two biggest are price risk and credit risk. You hedge the price risk with futures and you hedge the credit risk with CDS.

The physical trading of commodities is done between different counterparties and there is a time delay between when the deal is done and when oil is delivered. I believe it takes 40 days or so (depending on how full the pipeline is) for oil to flow from Canada down in to PADD 3 (Gulf Coast). There is a credit risk during that 40 day delay. Even though it is not likely that a counterparty defaults, in the unlikely event that one does, a trader could lose 10+ million. It is much safer just to hedge it with CDS.

Unlike a paper trader, a physical oil trader has to worry about supply and demand in different regions of the US (as well as what Brent and other grades of oil are doing abroad). They also have to look at transportation cost, storage costs, refinery set ups, ect.

Geographic Arbitrage in Physical Commodity Trading

Gekko21:

Different commodities can have slightly different prices based on their geographic location and the supply/demand in that area. There could be a lot of supply of crude in one pipline, but less crude in another geographic area which has a higher price (also different grades of crude have different finished product yields depending on the refinery set up). Those price differences allow for an arbitrage opportunity provided the transportation costs are less than the spread between the prices. Traders will conduct this arb until the spread disappears. In the oil market arbs can last weeks or even months because you are dealing with the actual delivery of a commodity. There are also global arbs. The Brent-WTI (Atlantic Arb) is the most commonly traded oil arb in the world with traders being able to take North Sea Brent and ship it across the Atlantic depending on WTI prices and freight costs----the trade can also go the other way with WTI going to Europe. There is also different supply and demand characteristics with finished products, Asian economies use Naptha as a blend stock for petrochemicals while American companies use Ethane and Propane----there is higher demand for Naptha in Asia than the US and refineries in the US can earn a profit by shipping their Naptha production to Asia.

Why do commodity houses exist?

They exist for the same reason that hedge funds exist--they provide increased liquidity and someone decided to start trading commodities with their own money that eventually became a large operation. They also invest in and build storage capacity which they use in their operations or can rent out.

Example Physical Commodity Trading Scenario

poorengineer - Sales and Trading Analyst:

As the others have said, location arbitrage is exploiting discrepancies between different geographical markets.

For example a product at New York Harbor might be trading over (premium) or under (discount) to a product in say Chicago. If you can buy the cheaper product in lets say Chicago and transport it to New York, you can capture the differential between the margin. Your margin will be dictated by transport (freight, rail, barge) rates and since these can also vary based on distance, time (prompt), fuel surcharges or even negotiations, there can be quite a bit of logistics involved in breaking up loads or re-directing loads to capture price differentials.

The advantages that these shops can offer are liquidity, pricing and flexibility with your goods--you don't want to be tied to one supplier since if anything happens to their logistics, for example a train delay, you should be SOL. Since you are delivering physical goods there is a very strong emphasis on relationship between you and your counterparties--if you are reliable and don't run someone dry, you'll see more repeat contracts and business.

You can see a picture that demonstrates the process of physical commodities trading below. You can read more about it on the Trafigura website.

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Comments (210)

Oct 5, 2010

Location arbitrage.

Oct 5, 2010

Leveraged metals houses were popular a decade ago, and a few might still be around. They make their money on margin interest and storage fees.

They were usually the last stop for guys who got kicked out of the commodities business, because selling the physical didn't require a license. So you can imagine that most leveraged metals houses were bucket shops.

Oct 5, 2010
Oct 5, 2010

Physical Commodity houses make money by trading commodities that actually exist. Even though a futures contract is physically deliverable, most positions are closed out before physical delivery needs to be made. They are not just trading a piece of paper that is worth 1,000 barrels. They literally trade barges of oil or oil in a pipeline that NEEDS to go somewhere.

There are a few risks for physical commodity prices, but the two biggest are price risk and credit risk. You hedge the price risk with futures and you hedge the credit risk with CDS.

The physical trading of commodities is done between different counterparties and there is a time delay between when the deal is done and when oil is delivered. I believe it takes 40 days or so (depending on how full the pipeline is) for oil to flow from Canada down in to PADD 3 (Gulf Coast). There is a credit risk during that 40 day delay. Even though it is not likely that a counterparty defaults, in the unlikely event that one does, a trader could lose 10+ million. It is much safer just to hedge it with CDS.

Unlike a paper trader, a physical oil trader has to worry about supply and demand in different regions of the US (as well as what Brent and other grades of oil are doing abroad). They also have to look at transportation cost, storage costs, refinery set ups, ect.

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Oct 5, 2010

Thanks. Can someone explain what location arbitrage is, and which commodities are used for it, some classic examples.

But the question regarding the right to exists of independent commodity houses still remains, what's the advantage of dealing with them instead of completely integrated companies like the oil majors?

Cheers,
Alain

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Oct 5, 2010
vanquan:

Thanks. Can someone explain what location arbitrage is, and which commodities are used for it, some classic examples.

But the question regarding the right to exists of independent commodity houses still remains, what's the advantage of dealing with them instead of completely integrated companies like the oil majors?

Cheers,
Alain

for me its exporting power from the midwest when prices falls and importing the crap out of it into cali as prices skyrocket.. aka enron

Oct 5, 2010
vanquan:

Thanks. Can someone explain what location arbitrage is, and which commodities are used for it, some classic examples.

But the question regarding the right to exists of independent commodity houses still remains, what's the advantage of dealing with them instead of completely integrated companies like the oil majors?

Cheers,
Alain

Different commodities can have slightly different prices based on their geographic location and the supply/demand in that area. There could be a lot of supply of crude in one pipline, but less crude in another geographic area which has a higher price (also different grades of crude have different finished product yields depending on the refinery set up). Those price differences allow for an arbitrage opportunity provided the transportation costs are less than the spread between the prices. traders will conduct this arb until the spread disappears. In the oil market arbs can last weeks or even months because you are dealing with the actual delivery of a commodity. There are also global arbs. The Brent-WTI (Atlantic Arb) is the most commonly traded oil arb in the world with traders being able to take North Sea Brent and ship it across the Atlantic depending on WTI prices and freight costs----the trade can also go the other way with WTI going to Europe. There is also different supply and demand characteristics with finished products, Asian economies use Naptha as a blend stock for petrochemicals while American companies use Ethane and Propane----there is higher demand for Naptha in Asia than the US and refineries in the US can earn a profit by shipping their Naptha production to Asia.

Why do commodity houses exist? They exist for the same reason that hedge funds exist--they provide increased liquidity and someone decided to start trading commodities with their own money that eventually became a large operation. They also invest in and build storage capacity which they use in their operations or can rent out. At the end of the day, they exist for the reason that any corporation exists....because they can make money.

Oct 17, 2010
vanquan:

Thanks. Can someone explain what location arbitrage is, and which commodities are used for it, some classic examples.

But the question regarding the right to exists of independent commodity houses still remains, what's the advantage of dealing with them instead of completely integrated companies like the oil majors?

Cheers,
Alain

As the others have said, location arbitrage is exploiting discrepancies between different geographical markets. For example a product at New York Harbor might be trading over (premium) or under (discount) to a product in say Chicago. If you can buy the cheaper product in lets say Chicago and transport it to New York, you can capture the differential between the margin.Your margin will be dictated by transport (freight, rail, barge) rates and since these can also vary based on distance, time (prompt), fuel surcharges or even negotiations, there can be quite a bit of logistics involved in breaking up loads or re-directing loads to capture price differentials.

The advantages that these shops can offer are liquidity, pricing and flexibility with your goods--you don't want to be tied to one supplier since if anything happens to their logistics, for example a train delay, you should be SOL. Since you are delivering physical goods there is a very strong emphasis on relationship between you and your counterparties--if you are reliable and don't run someone dry, you'll see more repeat contracts and business.

Oct 6, 2010

Wow you really know your energy stuff Gecko. Great post(s).

Oct 6, 2010

it is illegal to ship WTI out of USA. Plus it is a landlocked crude.

In theory it is easy to say "traders will conduct this arb until the spread disappears". This doesn't always happen in reality. Also the arb might be open for one person and closed for another.

Otherwise not a bad post.

Oct 5, 2010
pillz:

it is illegal to ship WTI out of USA. Plus it is a landlocked crude.

In theory it is easy to say "traders will conduct this arb until the spread disappears". This doesn't always happen in reality. Also the arb might be open for one person and closed for another.

Otherwise not a bad post.

It's illegal to ship WTI out of the US? I was under the impression that WTI was deliverable under the ICE contract just as WTI, Brent, Bonny Light, and a few other crudes were deliverable under the NYMEX contract.

Also, can't they ship it through a pipeline, load it onto barges and then put it on a Super Tanker off the coast of New Orleans (I think?) or get it onto barges and ship it up to NY?

Oct 6, 2010
Gekko21:

It's illegal to ship WTI out of the US? I was under the impression that WTI was deliverable under the ICE contract just as WTI, Brent, Bonny Light, and a few other crudes were deliverable under the NYMEX contract.

Also, can't they ship it through a pipeline, load it onto barges and then put it on a Super Tanker off the coast of New Orleans (I think?) or get it onto barges and ship it up to NY?

Ear is right ICE contracts are financially settled. They cease trading on the penultimate. Delivery only has meaning on the NYMEX contract.

You are right that WTI, Brent, Bonny Light and a few others are deliverable, provided they meet certain specifications. Brent which is inferior requires the seller be paid at 30c discount whereas for superior grades sellers are paid a premium, Bonny Light (+15c).

Delivery point is at Cushing which is landlocked (as mentioned in the above post), and you will need access to the pipelines to deliver. So not any Tom Dick or Harry can do so.

And no they cannot pipe it to the coast and sell it outside of the US simply because like i said it's illegal. Not that it cannot be piped or ship, but simply because it is against the law. If you are referring to NY, then it's doable (because it is domestic, not outside of US), but i don't think there are any crude streams in the US being priced off Brent.

Someone correct me if i'm wrong.

Oct 6, 2010

Gekko gave a great explanation. Read up on Glencore.

Oct 6, 2010

The ICE WTI contract is financially settled there is no delivery on it.
I haven't heard of the atlantic arb before but it could be possible i guess. Aren't there Grade differences between WTI and Brent?

Also phys commodity shops exist purely because the market demands for it. The forward curve for each commodity(contango or backwardated) shows the supply and demand out on the curve.If the mkt is in contango and it is wide enough it maybe advantageous to store the commodity and earn the carry of the curve. This is very common in the Nattie/CL and Ag mkts.

How can they be hedged?
-You can hold physical grain and hedge on the CBOT(CME).
The diff between Spot - future = Basis. If you run a hedged book your ultimately trading the basis.

Oct 6, 2010

I work for a physical Energy trading shop. The arbitrage described above is what our bread and butter business is, We transport crude oil, distillate, gasoline, Ethanol and NGL's using barges, pipelines etc.

I have never heard of it being illegal to ship WTI out of the USA. It most likely will never happen, as the US is still one of the biggest crude oil user and importer in the world. Thus, its hard to make a profitable trade to ship it abroad.

The location that someone spoke about in regarding to loading ships is LOOP. Stands for Louisiana Offshore Oil Port. You can offload VLCC's and ULCC's at this location and bring it into the Gulf Coast refineries systems using pipelines and barges.

WTI is landlocked but is also accessible to marine locations using pipelines. Specifically, the Pegasus pipeline which flows from Cushing to the Gulf Coast and Capline which goes from Louisiana to the Mid-Continent.

LLS grade crude oil is produced in the Gulf of Mexico and the new Bakken Field in ND (this crude really is a LLS lookalike but is traded using the LLS "basis" as a benchmark). LLS derives its value from the Brent-WTI relationship.

One of the other drivers of Brent prices (other than European demand) is the sulfur content of Brent crude.

Brent Crude frequently finds its way to the refineries in the Eastern coast of Canada. I would not be surprised if some of Valero's refineries at Paulsboro and Delaware city haven't used this grade before.

I look at a lot of offshore cargoes coming in daily to the GC, that use various different benchmarks. There are a lot of Saharan blends, Russian blends and South American crudes that find their way into the US.

As far as the OP's question about how these companies make money. Lots of producers and end-users are restricted in their ability to hedge and trade their systems. I am defining their "systems" as storage, pipeline shipping commitments, production and long-term supply/offtake agreements. Thus, companies like ours step in, take on long term commitments at index values (in case of physical product) and commitments on assets such as pipeline space and storage. Contango is ideally the preferred market structure for storage owners. We also make money on intermonth rolls on the NYMEX contracts etc. There is also a theory on physical players having better insight on NYMEX pricing and structure. But, that relationship seems to keep getting destroyed as energy becomes more of a mainstream asset class.

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Oct 7, 2010

Just so everyone knows, LLS stands for Light Louisiana Sweet.

"I just want to be a monkey of average intelligence who wears a suit. I'll go to business school!"

Oct 5, 2010

Thanks for the explanations. Are there other well known physical arbs that are traded beside the Atlantic arb, does the same exists within the metal space?

As much of the world's resources are based in political insecure countries, how do the commodity house trade with that problems? Do they just take this risk?

Is it right that within the commodity market a contango situtation is preferred by the traders as they simply can store and sell foreward? How do they deal with backwardation?

Cheers.

Oct 6, 2010

Depends on product. Each product has a distinct arb depending on S/D dynamic worldwide. For ex : Naptha is one of the biggest feedstocks in the Asian Pacific petchem plants. The biggest driver of Gulf Coast naptha pricing is the Asian arb. So, the point is arbs are infinite if you have the capability of transporting said commodity and taking on the risk of pricing and hedging.

It's an interesting dynamic. Even the most volatile countries have a tendering process where companies bid to either buy or sell commodities. I would assume Letters of Credit and prepayments are the norm depending on country. This is also one of the reasons, why commodity houses exist. To take on the risk and deliver products to users who do not have the ability to/don't want the risk of trading internationally.

In backward markets, you try to dump your storage, go short and buy the back of the curve and hope to god that the curve flattens.

Oct 5, 2010

location arb happens daily in nat gas and power

Oct 18, 2010

Another strategy that was very popular last year is playing the contango in crude. I think the last # I heard was about $0.90 per barrel per month to store crude offshore in a tanker. If the contango (future price - current price) is higher than that, then you buy crude today, store it and sell it later on when the price is higher. Not sure how much of that is still going on now with contango spread being much tighter.

Oct 18, 2010

Very informative thread. thanks all, keep em coming

Oct 26, 2010

Industry volume and nature of transactions.

Great thread. Does anyone have some colour they can shed on the size of physical commodity trading in North America as well as key markets. Namely, what I wish to know is the size of physical commodity trading in Canada versus the US. Also, is the nature of transactions typically booked on an exchange via standardized contracts or if this largely takes place off-exchange between supplier-producer.

Any insight is greatly appreciated.

Oct 6, 2010

Canada produces approx. 2.5 MM bbls/day of Crude. There is approx. 17 BCF of wet gas and 13-14 BCF of dry gas produced in Canada. Some of the gas is used in Canada while the rest goes South to Chicago and then onto New York. Gas also flows west to California and Oregon. Crude is primarily all flowing south to Chicago and then to Cushing and then even to the Gulf Coast. There are also imports of NGL's, crude and gas produced in the US that flows north into Canada.

Lot of gas trades on NGX clearinghouse from what I am told. I am sure tons of OTC stuff gets done too. Majority of crude and NGL's trade OTC and starting to somewhat trade on the NGX clearinghouse platform in the last 12 months or so. ICE, Argus, Platts are all trying to make inroads into the Canadian market.

Markets are nearly not as liquid as gas or refined products in the US. Relationships matter and traders still help each other when one finds themselves in a sticky situation.

I am in the energy trading biz in Canada if you have further questions.

Oct 26, 2010
ad2345:

Canada produces approx. 2.5 MM bbls/day of Crude. There is approx. 17 BCF of wet gas and 13-14 BCF of dry gas produced in Canada. Some of the gas is used in Canada while the rest goes South to Chicago and then onto New York. Gas also flows west to California and Oregon. Crude is primarily all flowing south to Chicago and then to Cushing and then even to the Gulf Coast. There are also imports of NGL's, crude and gas produced in the US that flows north into Canada.

Lot of gas trades on NGX clearinghouse from what I am told. I am sure tons of OTC stuff gets done too. Majority of crude and NGL's trade OTC and starting to somewhat trade on the NGX clearinghouse platform in the last 12 months or so. ICE, Argus, Platts are all trying to make inroads into the Canadian market.

Markets are nearly not as liquid as gas or refined products in the US. Relationships matter and traders still help each other when one finds themselves in a sticky situation.

I am in the energy trading biz in Canada if you have further questions.

Very informative! Any ideas on how to size up the total volume of physical trading that occurs for crude, NG and gold in Canada.

Perhaps the NGX is indicative of dry gas trading but then there is the NGL component in the OTC space which might bring total annual trading to ~ 30000 PJ?

As for crude, any way to measure the size of trading in OTC? How would one measure totals for Canadian trading volumes in this space?

Looking to gold, are there any markets / clearinghouses in Canada that you are aware of or would most Canadian trading in this space be captured on the COMEX?

Lastly, anyone have any thoughts out there the amount of activity that the Big 5 banks may have in the physical trading space in general?

I apologize for the scattered thought process of mine behind this but your feedback is greatly appreciated.

Oct 26, 2010

Natty in Canada is all traded on NGX. They will trade Midwest markets some day too.

The risk is also not just price and credit, but also getting the damn crap there. There is liquid pools and illiquid pools, each has its own pros and cons. But bottom line phsyical trading is not just paper money, you all learn in school. Shit actually blows up, weather actually changes, ppl do die,

Even financial points once we reach cash/pysical aka day-to-day this shit becomes real son, the goldmans of the world cant just beat it down like they do on financial products.

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Oct 6, 2010

Last month NGX traded approx. 410K BPD of Crude amongst 9 different grades. This is 15% of Canadian crude production. The rest is sold on term contracts and OTC as well. Think about it this way, atleast approx. 2.5 MM bpd trades every day notionally as these barrels have to leave Canada or go to a refinery to be processed. Some barrels go to storage. No idea on how to measure OTC volume.

No idea on NGL's as most trade OTC. C5 trades approx 15k bpd. Pipeline brings in approx. 40k bpd into Canada.

No idea on how much gas traded. Maybe someone else can pull that data.

Never ran into big 5 banks on the phys side. Have a Canadian bank that brokers financials a bit. Run into JPM, MS, Barclays, GS every now and then.

Jul 9, 2011

Could you tell me how these traders analyze if they go short/long?..Any mathematical proofs or just qualitativ analysis with luck?

Oct 26, 2010
Massiveattack1987:

Could you tell me how these traders analyze if they go short/long?..Any mathematical proofs or just qualitativ analysis with luck?

Depends on proudct and firm.

Jul 14, 2011

Great thread guys. I don't want to sidetrack this thing, but a quick side - Can someone give a brief description of what a physical energy trader actually does on a day-day basis?

And what skills do you think are most important for the job?

Oct 5, 2010
ibintx:

Great thread guys. I don't want to sidetrack this thing, but a quick side - Can someone give a brief description of what a physical energy trader actually does on a day-day basis?

And what skills do you think are most important for the job?

very high level move things from a to b for a profit

relationships is the strongest skill in my eyes and being able to form them

Jul 14, 2011
monty09:
ibintx:

Great thread guys. I don't want to sidetrack this thing, but a quick side - Can someone give a brief description of what a physical energy trader actually does on a day-day basis?

And what skills do you think are most important for the job?

very high level move things from a to b for a profit

relationships is the strongest skill in my eyes and being able to form them

Would you say energy trading a bit like derivatives market making in that you make money off the spread, albeit in a longer term than most liquid derivatives (if it takes 40 days to deliver)? but on the other hand, it is different in that there are way smaller number of participants in physical energy markets that the personal relationships with the clients actually matter a lot as opposed to a derivatives market maker who has plenty of anonymous customers(market participants) that buys/sells constantly without knowing who the buyer/seller is personally?

Oct 27, 2011

There's currently a decent spread between WTI and Brent that's wide enough to cover transportation and other associated costs involved in getting the stuff from Cushing (where you buy WTI and take delivery) to the Gulf (where you sell WTI at Brent prices). This spread obviously won't last and is in fact narrowing. Supposed one wanted to get into the trade - this is small stuff here, using trucks to transport a couple hundred barrels (per truck) at a time - is there a way to lock in the price differential, using futures, even though both activities will be unrelated for want of a better term. Basically, right now, there is an $18 spread between the two. Maybe this spread will be much narrower next year this time. How I can lock in the $18 difference?

Thanks

Jan 5, 2013
Le Capitalist:

There's currently a decent spread between WTI and Brent that's wide enough to cover transportation and other associated costs involved in getting the stuff from Cushing (where you buy WTI and take delivery) to the Gulf (where you sell WTI at Brent prices). This spread obviously won't last and is in fact narrowing. Supposed one wanted to get into the trade - this is small stuff here, using trucks to transport a couple hundred barrels (per truck) at a time - is there a way to lock in the price differential, using futures, even though both activities will be unrelated for want of a better term. Basically, right now, there is an $18 spread between the two. Maybe this spread will be much narrower next year this time. How I can lock in the $18 difference?

Thanks

You can trade the WTI-Brent as a product in itself, its on the ICE.
Of course, going short $18 would NOT have made you money btw.

Mar 5, 2013
Le Capitalist:

There's currently a decent spread between WTI and Brent that's wide enough to cover transportation and other associated costs involved in getting the stuff from Cushing (where you buy WTI and take delivery) to the Gulf (where you sell WTI at Brent prices). This spread obviously won't last and is in fact narrowing. Supposed one wanted to get into the trade - this is small stuff here, using trucks to transport a couple hundred barrels (per truck) at a time - is there a way to lock in the price differential, using futures, even though both activities will be unrelated for want of a better term. Basically, right now, there is an $18 spread between the two. Maybe this spread will be much narrower next year this time. How I can lock in the $18 difference?

Thanks

Just re-read this one... Not all of these details are accurate, but the general idea is what is important (Louisiana Sweet is the benchmark for GC crude. It's highly correlated with Brent, but not perfect).

I thought the same thing about this spread at the time, but we both would have been VERY wrong paper trading that spread. All you would have to do is buy WTI and sell Brent as hedges, then unwind those hedges when your physical cargo prices in. You would probably buy the physical product based on the average price in the days surrounding the Bill of Lading. Whatever your pricing exposure is on those days, you unwind that number of hedges to manage your risk properly.

I will make a post about how this is done in the near future.

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Nov 27, 2011

Does anybody know some of the major physical shops?

Oct 5, 2010

define major?

Nov 27, 2011

I don't have any requirements for major, but I was thinking the top 10 or so in terms of AUM.

Feb 15, 2012

Hi,

Interesing thread....

A couple of questions:

  1. Is a license required to trade physical oil, fuels, and petrochemicals within the U.S. or internationally?
  2. Are there any courses on this that you know of?

Thanks

Feb 15, 2012

Reading Oil 101 helps me understand this thread much better

Dec 24, 2012

Hi Everyone,

Thanks for providing such information

Dec 30, 2012

Great thread guys, as someone who is new to physical crude trading what hedges would you recommend implementing to protect a cargo of Petroleum bought today for future delivery in one region on local pricing with intention to deliver if by sea to a different region on totally different pricing??

Jan 5, 2013
bsasegbon:

Great thread guys, as someone who is new to physical crude trading what hedges would you recommend implementing to protect a cargo of Petroleum bought today for future delivery in one region on local pricing with intention to deliver if by sea to a different region on totally different pricing??

Not in the industry, so please correct me if im wrong. I would say a combination of hedging via a future contract to expire after the delivery of your cargo (currency and the oil grade ur trading). You might want to buy a credit default swap to remove counter party risk. Also, be sure not to get screwed on the bill of lading (read the fineprint) and double check the demurrage terms in case of logistical problems at the port, bad weather or low tides.

Dec 30, 2012

Not in the industry, so please correct me if im wrong. I would say a combination of hedging via a future contract to expire after the delivery of your cargo (currency and the oil grade ur trading). You might want to buy a credit default swap to remove counter party risk. Also, be sure not to get screwed on the bill of lading (read the fineprint) and double check the demurrage terms in case of logistical problems at the port, bad weather or low tides.[/quote]

Thanks a lot for your help, thats exactly what I was looking for. So besides price and counter-parties is there anything else that might need to be hedged against?

Nov 3, 2014

Hi there, I have an interview at an oil trading company (graduate scheme). Do you know if they will expect us to be this technical (I.e. did you have a similar interview)?

Thanks in advance, appreciate your help.

Dec 15, 2014

Can any post a list of resources (books, articles, videos, etc.) where one can go and learn more about the industry and how the commodities houses are run? Thanks!

Dec 15, 2014

Can any post a list of resources (books, articles, videos, etc.) where one can go and learn more about the industry and how the commodities houses are run? Thanks!

Dec 26, 2014

Hi, I have a video interview with a physical commodities trading firm. Any suggestions on how to prepare ?

_G

Dec 26, 2014

Hi, I have a video interview with a physical commodities trading firm. Any suggestions on how to prepare ?

_G

Oct 5, 2010

pay out depends on firm and trader.. no two are alike

Dec 26, 2014

very insightful. Does anyone who actually work/worked for these firms have any insight?

Dec 26, 2014

10-12% is more common, bear in mind though that upto 50% of this can be in stock, sometimes vesting over as long as 5 years.

Dec 26, 2014

Agree with Monty, these firms can structure thier offer however they want, depending on how badly they want to hire you (at the senior level anyway), there is no 'standard' at these kind of shops.

Oct 6, 2010

We pay 17%..very similar to one of the shops you listed above..

Dec 26, 2014

How do you determine the payout for a single trader in a particular location, if there is a significant part of his book that involves arbitrage cargos? I.e he could be the one sourcing or he could be the one marketing the cargo.

Dec 26, 2014

At a top place like Glencore, a general rule of thumb is that 10% of group P&L is available for bonuses. You're smoking dope if you think you'll personally get 10% on what "you have" brought in for the group. In reality, your personal number might be more like 2-6% depending on how senior you are and how easy it is to show attribution that you're truly the one responsible for the return.

Dec 26, 2014

EarTotheStreet,

The move from analytics to trading work out?

Where'd you end up?

Dec 26, 2014

anywhere between 10-20% is pretty standard payout for a trader on the buyside regardless of the product. And yes it is in writing for sure.

Dec 26, 2014

You beat me to it. The bigger and related story of the day is that John Arnold is shutting down the Centaurus Master Fund. He doesn't get nearly as much attention as some of the other HF managers here on WSO. I've always looked up to the guy.

I'm a commodities guy, but my background is financial/derivatives.

NATURAL GAS HEDGE FUND MANAGER JOHN ARNOLD TELLS INVESTORS HE IS CLOSING Centaurus Energy MASTER FUND - RTRS

Dec 26, 2014

Look a the massive profits from the commodities firm (Vitol, Glencore,...) that mainly trade physical.
I don't believe that paper is going to decline anytime soon.

Dec 26, 2014

Revenues:

Gunvor: US$65 billion
Vitol: $195 billion
Glencore: $186.2 billion
Xstrata: $33.8 billion
Mercuria: $47.2 billion
Cargill: $119.5 billion

How many employees do each of these firms have in their marketing divisions? 1000-2000? 3000 max?

The HBS guys have MAD SWAGGER. They frequently wear their class jackets to boston bars, strutting and acting like they own the joint. They just ooze success, confidence, swagger, basically attributes of alpha males.

Dec 26, 2014
SonnyZH:

Revenues:

Gunvor: US$65 billion
Vitol: $195 billion
Glencore: $186.2 billion
Xstrata: $33.8 billion
Mercuria: $47.2 billion
Cargill: $119.5 billion

How many employees do each of these firms have in their marketing divisions? 1000-2000? 3000 max?

Each? That seems really high.

Dec 26, 2014

The hedgies have had a challenging couple years. John Arnold probably had the most meteoric rise to HF riches of any trader I can think of. Can't blame him for retiring considering the money he's made.

Dec 27, 2014

A fair amount of Glencore's revenue is from production not marketing/trading activities. Most of Xtrata's is from production. Not sure about the rest.

Dec 26, 2014
safricactury:

A fair amount of Glencore's revenue is from production not marketing/trading activities. Most of Xtrata's is from production. Not sure about the rest.

Obviously, especially if they move in for long-term investments through buying mines, etc.

TheSquale:

What do you mean by marketing ? For me it's how to create and maintain good relationship whith customers, I don't think that it's what u're talking about.

Marketing commodities, they produce, store and transport these globally (trade them).

The HBS guys have MAD SWAGGER. They frequently wear their class jackets to boston bars, strutting and acting like they own the joint. They just ooze success, confidence, swagger, basically attributes of alpha males.

Dec 26, 2014

What do you mean by marketing ? For me it's how to create and maintain good relationship whith customers, I don't think that it's what u're talking about.

Dec 27, 2014

Glencore has offtake agreements with mining majors like Anglo, BHP etc. They purchase the material from these producers and market it to end clients. This is called 3rd party marketing.

Dec 26, 2014

Didn't know that SonnyZH. Physcial trading is a pretty huge industry when you consider all the stuff on the side as well: shipping, trade finance, warehousing... And obviously the numbers explode if you consider producers.

Dec 27, 2014
GoodBread:

Didn't know that SonnyZH. Physcial trading is a pretty huge industry when you consider all the stuff on the side as well: shipping, trade finance, warehousing... And obviously the numbers explode if you consider producers.

yea its not just pure paper trading... all the various logistics need to be handled well too.

Dec 27, 2014

the day every aspect of physical trading can be done by algo's is the day we might as well all stop fucking working. if an algo can get a ship out of some of these fuckers, it's the most advanced AI out there.

Dec 27, 2014

I work at a midstream company and we do a lot of physical trading, especially around assets we own and can leverage off of. Commodities are real goods used for real purposes that require reaching real destinations. Physical trading will always be important and will always be a large business. There are so many market inefficiencies due to infrastructure constraints that there will be growth in this space for many years to come.

The article was simply pointing out that paper traders no longer require extensive experience on the physical side. A lot of hedge funds might not care about the physical market because they understand the other dynamics behind the paper products. They might understand the global economics that impact WTI pricing and take a position based on that. With the ability to leverage, this might dwarf (in financial terms) any of the physical movements. But the physical guys will still move those WTI based barrels because oil needs to refined and sold. Hell, there are so many products out there that don't even have a futures market that the physical guys operate in a completely different space than guys taking a spec position on paper.

Now the reason for a decline in the number of physical traders may be (and this is just my guess) that there is consolidation in the market where a few dominant firms are now running the show in their respective spaces. This means they have a lot of assets to trade around and have access to a lot of information. Therefore one guy can make better and more informed decisions vs many years ago in a more fragmented market where it may have been advantageous to have more traders to gain that insight

    • 2
Dec 27, 2014

Can any on who has experience working on trading desk answer this question what is the real role of the commodity exchange?

I am confused here why would any commodity producer (oil, gas, sugar) would sell his product in the exchange (ICE, Chicago mercantile exchange, new York mercantile exchange) specially that the spot market is way high that the paper market (sugar for example)

Those big commodity trading houses (Cargill, Louis dreyfus, glencore) I thought they are just doing PAPER trading but NO they are doing physical as well. But what is the role of the exchange? For example I called a sugar company asking for 10 metric tons and they quoted the price at 820 while in London it is traded at 570. if that's the case who is the company that is going to sell a contract of sugar in the market if it is in the Canadian market at 1200 spot and in the American market at 1280. Can not they just sell that directly in the market? In other words, coming the delivery month, there is going to be about 12000 mt standing for delivery. Who is the stupid who sold that in the exchange for 570 while he can sell them in the physical spot market for double the price? The same thing for oil, cotton , cocoa and so on

Dec 26, 2014
MD finance:

Can any on who has experience working on trading desk answer this question what is the real role of the commodity exchange?

I am confused here why would any commodity producer (oil, gas, sugar) would sell his product in the exchange (ICE, Chicago mercantile exchange, new York mercantile exchange) specially that the spot market is way high that the paper market (sugar for example)

Those big commodity trading houses (Cargill, Louis dreyfus, glencore) I thought they are just doing PAPER trading but NO they are doing physical as well. But what is the role of the exchange? For example I called a sugar company asking for 10 metric tons and they quoted the price at 820 while in London it is traded at 570. if that's the case who is the company that is going to sell a contract of sugar in the market if it is in the Canadian market at 1200 spot and in the American market at 1280. Can not they just sell that directly in the market? In other words, coming the delivery month, there is going to be about 12000 mt standing for delivery. Who is the stupid who sold that in the exchange for 570 while he can sell them in the physical spot market for double the price? The same thing for oil, cotton , cocoa and so on

Commodity futures contracts are exchanged this way.

Different commodities can have slightly different prices based on their geographic location and the supply/demand in that area. There could be a lot of supply of crude in one pipline, but less crude in another geographic area which has a higher price (also different grades of crude have different finished product yields depending on the refinery set up). Those price differences allow for an arbitrage opportunity provided the transportation costs are less than the spread between the prices. traders will conduct this arb until the spread disappears.

The HBS guys have MAD SWAGGER. They frequently wear their class jackets to boston bars, strutting and acting like they own the joint. They just ooze success, confidence, swagger, basically attributes of alpha males.

Dec 26, 2014
MD finance:

Can any on who has experience working on trading desk answer this question what is the real role of the commodity exchange?

I am confused here why would any commodity producer (oil, gas, sugar) would sell his product in the exchange (ICE, Chicago mercantile exchange, new York mercantile exchange) specially that the spot market is way high that the paper market (sugar for example)

Those big commodity trading houses (Cargill, Louis dreyfus, glencore) I thought they are just doing PAPER trading but NO they are doing physical as well. But what is the role of the exchange? For example I called a sugar company asking for 10 metric tons and they quoted the price at 820 while in London it is traded at 570. if that's the case who is the company that is going to sell a contract of sugar in the market if it is in the Canadian market at 1200 spot and in the American market at 1280. Can not they just sell that directly in the market? In other words, coming the delivery month, there is going to be about 12000 mt standing for delivery. Who is the stupid who sold that in the exchange for 570 while he can sell them in the physical spot market for double the price? The same thing for oil, cotton , cocoa and so on

You know what hedging and the basis are right?

Dec 27, 2014

What is the point of most future contracts if they are never delivered?

Dec 27, 2014
Crass009:

What is the point of most future contracts if they are never delivered?

According to text books and theory, it is hedging. Only 20% of contracts end in real delivery and 80% are offset before the delivery month

Dec 27, 2014

You are confusing yourself with all the various numbers which relate to different things.

Transportation costs are not higher than any arb, it depends on various factors. Paper trading can be speculative, but it can also be used as a hedge to protect against future price fluctuations in the physical market. So for instance, if your company buys physical sugar and has to ship it to your location from the field or wherever, you will want to hedge it so that you minimize the risk of the price fluctuating while the sugar is being transported. Your company will use the futures contracts to hedge the physical, hence the exchange.

There are various reasons why the physical and financial prices do not always match up (such as grade / quality differences, location, fx, etc), but likely it means you are missing something in your analysis, not that another sophisticated market participant is clueless about the markets. I can guarantee you that your company does not simply buy large amounts of sugar in the spot market as their sole sourcing strategy. There will be storage, hedging, term contracts, there will be multiple components to how they source their sugar. To go spot all the time would mean you take on considerable risk which no large company would do because that would be true speculation.

Dec 27, 2014

John Arnold closed Centarus because it's impossible to make money trading natural gas when the federal government and the USDA go to extreme lengths to depress that market and keep prices artificially low. The story for natural gas is extremely bullish, but the government is too in bed with the corn industry.

When you start seeing companies offering cars that run on nat gas, fill stations offering facilities conducive to those cars, and the USDA admitting that the conversion rate for ethanol is actually 2.8 gallons / bushel of corn instead of 2.1 gallons / bushel, Arnold will be back. And I actually see most of that stuff happening within the next 3 years.

For now, he can enjoy being an under-40 billionaire.

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Dec 27, 2014

buy the book - Oil 101. Good book on oil and gas and written by an ex physical trader. From here its all about reading and networking..

Dec 27, 2014

UnclePanda...I looked at table of contents of this book and it seems like it only discusses oil and refined products.

Dec 27, 2014
Onyxcap:

UnclePanda...I looked at table of contents of this book and it seems like it only discusses oil and refined products.

just read it and you'll figure out why it's relevant

Oct 26, 2010

energy trading and investing is the book i prefer.

Dec 27, 2014

Oil 101 is a good overview the the whole industry from e&p to refining and marketing

Dec 27, 2014

The EIA typically has good material -- see the link below -- provides you with good insight into the road map that is pipelines throughout the Continental U.S.

http://www.eia.gov/pub/oil_gas/natural_gas/analysi...
Also, I'd rather see people learn from material on the web that we use in the industry as opposed to reading a book off the book shelf. While I have learned a thing or two from books, I must say that the majority of my learning came from industry based news -- whether it be government driven ie. EIA or third-party research such as OPIS.

Dec 27, 2014
Urban Guerrilla:

The EIA typically has good material -- see the link below -- provides you with good insight into the road map that is pipelines throughout the Continental U.S.

http://www.eia.gov/pub/oil_gas/natural_gas/analysi...
Also, I'd rather see people learn from material on the web that we use in the industry as opposed to reading a book off the book shelf. While I have learned a thing or two from books, I must say that the majority of my learning came from industry based news -- whether it be government driven ie. EIA or third-party research such as OPIS.

any other suggestions for what to read?

Oct 26, 2010
Urban Guerrilla:

The EIA typically has good material -- see the link below -- provides you with good insight into the road map that is pipelines throughout the Continental U.S.

http://www.eia.gov/pub/oil_gas/natural_gas/analysi...
Also, I'd rather see people learn from material on the web that we use in the industry as opposed to reading a book off the book shelf. While I have learned a thing or two from books, I must say that the majority of my learning came from industry based news -- whether it be government driven ie. EIA or third-party research such as OPIS.

I agree, but you need to get an understanding of what tport and storage are to begin with. The book I mentioned I give or recommend to anyone who joins our firm. The main thing is understanding storage and weather, how the two equalize the market at all times any trade you have is based off that idea. Same reason something like QE could move every commodity except natty since it beats to its own drum due to the 4.2tcf storage we gots.

http://www.naturalgas.org/naturalgas/naturalgas.asp is decent site too, a history lesson never hurt anyone.

Dec 27, 2014

I agree - I've found the EIA a very valuable resource. Importanty, it is up to date, free and thorough. It's hard to find material that specifically focuses on fundamental pillars without embedding them in an example, but on the upside, you have to dig your way through the material and learn it all using relevant examples. Another great site is: http://www.jai-energy.com/

1.) What do you want?
2.) What realities are between you and what you want? What is true?
3.) What are you going to do about it?

Dec 27, 2014

Spot on MW -- transportation is KEY -- boils down to value at the destination..which traders take the value and subtract out transportation cost, thru- put cost, and looking at the most efficient routes/ cost basis for each route. Storage is just as important -- especially when dealing with arbs and production levels..some producers can get squeezed when times are tough and get crushed by traders that can sell out their storage at a discount to production break-even econs creating artificial values in the market

Dec 27, 2014

Thank you all. I understand basics of natural gas storage and prices as well as power prices in various ISOs. I guess what I am looking for is more information on storage and pipelines operations and flow of natural gas.

Oct 26, 2010
Onyxcap:

Thank you all. I understand basics of natural gas storage and prices as well as power prices in various ISOs. I guess what I am looking for is more information on storage and pipelines operations and flow of natural gas.

If you looked at the resources listed you could see they provide exactly that framework.

Dec 27, 2014

I have one more firm resource-- see below:

http://www.ingaa.org/Topics/1330.aspx
Also offers project downloads so you'll have talking points during interviews about things happening "in the market".

Download/ print out a pipeline map and learn all the major pipelines, evaluate all potential arbs based on spot/forward prices and geographical location. Start looking at transportation cost and see what's feasible. I am not offering any books because I believe the best education is material that I would actually use at work. I've ready many of the oil/gas/energy books over the years and found tidbits useful, but nothing near the usefulness of actual data and research.

Dec 27, 2014

If you are planning to get into natural gas trading, I suggest getting yourself a bentek map and familiarize yourself with all the major hubs and what pipelines they connect to

Dec 27, 2014

Unless you already have experience trading a product, there should be no problem with diversifying your options.

Dec 27, 2014

Whatever gets you to a desk.

Dec 27, 2014

I have a bad feeling about this

Dec 27, 2014

And with recent news showing they manipulated aluminum prices - They won't be trading phyiscals

Dec 27, 2014

I have absolutely no idea why deposit-taking banks should be allowed to trade physical commodities. It's utterly absurd.

Oct 26, 2010
Martinghoul:

I have absolutely no idea why deposit-taking banks should be allowed to trade physical commodities. It's utterly absurd.

While I agree, the advantage is there just like any other investment banking activity. They are able to secure financing and internal hurdles are much lower allowing them to secure physical assets (options) at a much lower cost than others in the marketplace, using such assets to create alpha. Same as why they are in the real estate private equity game.

Dec 26, 2014
Martinghoul:

Don't get me wrong, I understand perfectly why it makes sense for banks to be involved in physical commodity trading. What I don't understand is why it makes sense for society as a whole to let them.

I doubt physical activity will continue much longer in banks, regulatory changes are squeezing small margins as it already is. The real physical houses don't have to deal with these issues.

The HBS guys have MAD SWAGGER. They frequently wear their class jackets to boston bars, strutting and acting like they own the joint. They just ooze success, confidence, swagger, basically attributes of alpha males.

Oct 26, 2010

If they are or want to trade in the US, they most certainly have to do deal with the various regulatory changes. Ice position limits, reporting of swaps, etc all apply to anyone not just "banks". That said banks have the worse designation as a "bank swap dealers" and the heaviest of rules go against them.

Also all banks exiting the space in the long-run is a not a good thing for trading/commodity/physical shops...not good at all.

Oct 26, 2010

I would say, since I work in the space Energy is one of the most affected and at risk markets. Power very much so since a lot of customers are "government owned entities" which is where the worse of DF rules come into play.

Less liquidity/efficiency could be a good thing for a prop trader or market that is monopoly controlled. Otherwise in most other cases it is horrid for flow traders. Let's say customer X, has a cost base of 100..efficient hedging, etc allows that cost base to maybe go down to 70, the customer executes. What if that cost base only goes to 90? Does the customer care, will they hedge, will they find a long-term solution etc... Angry/confused customers are not motivated ones.

Now could fear force hedging and volumes, ofcourse look at 2000-2008, but then you need to pray for a supply shock that hurts the customer's bottom line, those do not come around all the time.

If anyone has different views/comments I would like to hear them, i.e. has the new rules made it easier in metals, FX, etc..

Dec 27, 2014

Banks have many reasons to trade physicals. Banks often execute physicals contracts for clients. For example if you wanted to buy 1000 micro oil contracts you could go to your bank to source the contracts through their market desks. I don't see any problem with this, nor do I see any problem with banks running prop desks. Everyone freaks out about banks trading their own accounts. The real problems are systemic problems created by political meddling in the system not a bank by bank issue.

Follow the shit your fellow monkeys say @shitWSOsays

Life is hard, it's even harder when you're stupid - John Wayne

Dec 27, 2014

1000 micro oil contracts? The ones traded on the CME? I am not sure this falls under physical commodity trading, given it's an exchange-traded derivative.

The problem with banks doing all these things is always the same, namely that all these activities are, unfortunately, subsidised by the taxpayer.

Dec 27, 2014
Martinghoul:

1000 micro oil contracts? The ones traded on the CME? I am not sure this falls under physical commodity trading, given it's an exchange-traded derivative.

The problem with banks doing all these things is always the same, namely that all these activities are, unfortunately, subsidised by the taxpayer.

That was just an example, the point I was making was that banks provide services to their customers and are not just trading on their own accounts.

Follow the shit your fellow monkeys say @shitWSOsays

Life is hard, it's even harder when you're stupid - John Wayne

Dec 26, 2014

http://www.ft.com/intl/cms/s/0/4901bdaa-f627-11e2-...

JPM is looking to exit the industry altogether after MS failed last year to sell a stake of its business. Tough times ahead.

Dec 27, 2014

you can summarize the difference by looking at which shops are public and which are private, and just following the implications of that to their logical ends

Dec 27, 2014

what do you mean by this?

Dec 27, 2014

I am gonna be in Shell Trading next summer, but I can tell you BP/Shell gives a better fundamental training to be a good energy trader. I read somewhere on this forum that people from grad programs for the trading houses tend to end up in mid/back office.(Not entirely sure) From what I heard and talked to (people in the energy industry), Shell and BP would be a very solid start to a trading career.

Dec 27, 2014

People from grad programs at trading houses do not usually end up in mid or back office. "I read somewhere on this forum" is about the worst source you can have for this, especially since you haven't started yet. Also, people from the supermajors (even if they've "traded" a little bit) still usually have to do a year or two in mid/back office before they're allowed to trade again at a trading house.

Not bashing supermajors, just saying that what you're saying isn't very accurate and is borderline misleading.

Dec 27, 2014
Dec 27, 2014

don't forget Trafigura, Noble, Gunthor and dozen other low profile sharks.

yeah it could be profitable. Physical trading is much more different from financial trading. You take on a much more administrative and people oriented role. It's not like clicking the buy and sells on a trading platform after doing some due diligence from public information. No, you talk to people and hunt for market information, develop relationship with counter parties, make sure the paperwork gets signed, and logistics do their job in getting the transport for your goods from A to B, when the pipeline breaks down or your trucks ain't going from point A to point B, you get on the phone and sort it out with the field guys. Lots of informal contracts done over some emails and words of mouth.
and on and on. not for the faint hearted.

    • 3
Best Response
Dec 27, 2014

1. Price Discovery: Each region of the globe has different supply/demand dynamics that are not easily known, unlike stocks or futures. Prices within one hundred miles can vary wildly without every market participant knowing this. Traders who can understand these regional differences are able to capitalize on them and profit. This is done by forging relationships with counter-parties in order to gain information that others do not have.

2. Specifications: Although physicals are commodities, buyers can often vary in what specifications they are willing to accept and sellers vary in what they can offer. Traders are able to capture these differences. This goes hand in hand with price discovery; as the old saying goes, one man's trash is another man's treasure.

3. Logistics: Anyone idiot can buy and sell physicals. The real meat of the trade is in the execution. Understanding freight, storage, and opportunity cost is the hallmark of a good physical trader. Your reputation in physical trading is determined by the volume of profitable trades you execute successfully, not the trades that you put on paper that look good but can't be executed. Traders who can execute consistently can command higher margins.

4. Relationships: Price is not the only thing that drives the decisions of buyers and sellers. Traders who can ingratiate themselves with their counter-parties by knowing where the market is (price discovery), understanding the buyer's or seller's needs (specifications), and executing reliably for the counter-party (logistics) can often protect their markets from interlopers and command higher margins on their products.

Large firms can offer informational advantages simply because of their reach, but there are also smaller companies that do extremely well by working within a niche market (either product or region) and knowing the ins and outs of that market better than anyone else. Physicals continue to look bright because of growing markets and huge logistical issues that offer tremendous opportunities for skilled traders.

    • 7
Dec 27, 2014
BOTT1702:

1. Price Discovery: Each region of the globe has different supply/demand dynamics that are not easily known, unlike stocks or futures. Prices within one hundred miles can vary wildly without every market participant knowing this. Traders who can understand these regional differences are able to capitalize on them and profit. This is done by forging relationships with counter-parties in order to gain information that others do not have.

2. Specifications: Although physicals are commodities, buyers can often vary in what specifications they are willing to accept and sellers vary in what they can offer. Traders are able to capture these differences. This goes hand in hand with price discovery; as the old saying goes, one man's trash is another man's treasure.

3. Logistics: Anyone idiot can buy and sell physicals. The real meat of the trade is in the execution. Understanding freight, storage, and opportunity cost is the hallmark of a good physical trader. Your reputation in physical trading is determined by the volume of profitable trades you execute successfully, not the trades that you put on paper that look good but can't be executed. Traders who can execute consistently can command higher margins.

4. Relationships: Price is not the only thing that drives the decisions of buyers and sellers. Traders who can ingratiate themselves with their counter-parties by knowing where the market is (price discovery), understanding the buyer's or seller's needs (specifications), and executing reliably for the counter-party (logistics) can often protect their markets from interlopers and command higher margins on their products.

Large firms can offer informational advantages simply because of their reach, but there are also smaller companies that do extremely well by working within a niche market (either product or region) and knowing the ins and outs of that market better than anyone else. Physicals continue to look bright because of growing markets and huge logistical issues that offer tremendous opportunities for skilled traders.

Would like to add 4 specific PL drivers:

1. Freights plays:

It costs aprox. $10 less per wmt to ship 15k wmt of copper concentrates from point a to point b than it does 5k wmt.

If you buy 15k wmt of mineral in Chile and then line up three different smelters in Asia for 5k wmt clips, you pocket this freight differential.

This is most simple example I can think of, but there are many other pays: taking tonnage on COA or time charters and then using it to cover spot shipments, taking directional positions on freight market, cost savings from operating own fleet, etc.

2. Blends

You buy 1,000 wmt of shit, and 1,000 wmt of super clean concentrates. Blend that and you end up with 2,000 wmt of OK grade material. Since the difference between OK and super clean materials is MUCH smaller than difference between shit and OK materials, you make money by blending.

3. Financing

Trading houses have much lower costs of financing than most commodity producers and suppliers.

Additionally, trading houses understand the risks involved in producing and processing commodities much better than banks.

Consequently, traders can borrow cheap and lend at higher rates to their clients and suppliers.

They further benefit from this interest rate arbitrage by being in a much better position to monetize collateral (as opposed to a traditional lender).

I.E. It is much easier for a trader to take the couple thousand tonnes of raw ore which a mine posted as collateral on a defaulted loan, pay someone to process it into concentartes or metal, and then sell that than say a bank would. Same goes for productive assets etc (a trader might even want to keep the mine or plant on its books after having executed the guarantee, whereas a bank is probably not even allowed to hold the mine and will have to sell it for cents on dollar).

4. There are some strategies you can ONLY do if you have access to physical (i.e. physical warehousing deals when contango on metal is higher than insurance, interest and storage costs).

My two cents.

Dec 27, 2014

Physical trading involves spending time and experience to cultivate a very specific skill-set. This will involve learning the the ins/outs of logistics, basis spreads, freight arbs, draft sizes for water-born terminals and the variety of players in your markets. In the process you will typically have a huge informational advantage over a screen trader--now whether it's more profitable or not will vary by your commodity/market.

Dec 27, 2014

yes there is an informational advantage. there's also a regulatory advantage. truth is to be able to trade commodities well in a speculative way, it really helps to understand the physical mkt. at the end of the day the price of oil is based on how much physical oil is being produced and consumed

    • 1
Oct 26, 2010

Because as Propane/Natty/Heating Oil/Power have shown this winter, there is massive VAR and risk that most people do not understand. Historically volatility in these markets was very high for a period of time then it went away over the last 4months its back and its ugly back, many sleepless traders and marketers out there. You may ask why is so much VAR unknown the reason is because "real life happens", black swan events in the physical world happen all the time from accidents/strikes/weather/new technology/new discoveries etc... There is so much imperfect information.

At the most basic level when you model risk in Physical world you do not even use a B-S or style model, its usually a very compliated binomial or monte-carlo style.

Lastly, WSO glamorizes shit big time, its only profitable if you have the right assets, connections or win there is lots of losers out there, lots and lots.

    • 4
Dec 27, 2014

Thanks to everyone for sharing - SB's for all! I've been reading Oil 101 and surprisingly, I do find myself interested in the technicalities of the oil industry.

Can I just ask how much of the job is driven by relationships? I don't consider myself a natural salesman and it seems like this could limit my potential.

Also, how much travelling is involved in physical (oil) trading? Would you be inspecting the assets/wining & dining counterparties?

Thanks again!

Dec 27, 2014
Dece:

Can I just ask how much of the job is driven by relationships? I don't consider myself a natural salesman and it seems like this could limit my potential.

Marc once told one of my bosses "There are 3 secrets to trading; personal relations, personal relations, and personal relations".

Dec 27, 2014

Also interested.

What is more profitable generally, agri or energy ? short/long run...

Thanks

Dec 27, 2014
tonixity:

Also interested.

What is more profitable generally, agri or energy ? short/long run...

Thanks

There is no such thing as a more or less profitable trade or product: profits cannot be analyzed in isolation of risk.

What I am getting at, is that what you should really compare is profit vis-a-vis the amount of risk you take on.

Dec 27, 2014

Just curious - because relationships with counter-parties are a big part, are bridges ever burned? If so, what are the consequences? Can anyone give an example how this might happen?

Dec 26, 2014

This happened at a very shady shop in Eastern Europe, definitely not your Glencores of the world but:

A buddy of mine had to renege on a steel deal because the firm had virtually no working capital and a bunch of deals had fallen through for other traders, meaning my buddy couldn't pay for the steel he was buying. My buddy ended up quitting over it because he felt he was toast. He was basically buddies with the counterparty in question but the guy never talked to him again.

Then again, that firm is still kicking.

Dec 27, 2014

for real-time traders in bilateral markets this happens all the time. you're always on the phone and traders will naturally build relationships with other traders. piss off a trader at a different company and they will be less likely to trade with you. this is on a personal level not on a company level. just dont be a dick when talking to counterparties.

Dec 27, 2014

Doesn't the answer essentially come from the fact that they are typically less liquid markets with less transparency?

Dec 27, 2014

Do you think commodity houses are the place to be now just like HFs ?

Dec 26, 2014
tonixity:

Do you think commodity houses are the place to be now just like HFs ?

Don't worry so much about "the place to be right now." By the time you hit your peak earning years, it will be different.

Dec 27, 2014

Thanks for the help everyone. What are the hours for physical oil trading like? I've seen 40 - 50 hours floating around.

Thanks!

Dec 27, 2014

There is some very good comments over here, thanks contangoman, blender, marcellus_wallace and BOTT1702 for chiming in.

Oct 26, 2010

Regulations, IT, etc all impact physical trading shops not just banks that is a misconception. They are just different impacts some banks have decided to focus on brokeage, FX, fixed income and let go of commodities. Outside of some extreme bank capital rules most of the same rules apply to any major physical trading shop.

Dec 27, 2014

I am new to this forum but I am interested in working in grains and coffee commodities. How do you approach a physical trading shop to ask for internship?

Dec 27, 2014
Ah-Meng:

I am new to this forum but I am interested in working in grains and coffee commodities. How do you approach a physical trading shop to ask for internship?

I don't know how old you are / what previous experience you have. For sophomores and juniors who perhaps would be overlooked for roles at physical shops i would HIGHLY suggest trying to land an internship with one of the myriad support / service sectors, or with a commodity prodicer / consumer first.

Competition for places is much lower, they are not used to receiving as many cold calls / emails for people asking for internships, and you will learn a lot of actually useful information / make your CV stand out when you do go for a trading position...

For example, an aspiring coffee trader could get experience -and boost his CV prior to applying to a position at a trading shop- at any of the following type of companies:

+ container shipping company / freight forwarder / warehouse (Look up Steinweg)
+ a coffee futures broker or dealer (look up Marex Spectron, etc)
+ a coffee roaster
+ trade finance department at ANY bank
+ getting your ass down to ivory coast or brazil and working for a farm (you can probably do this through some sort of volunteer organization for poor farmer's or whatever, but GREAT way to understand the most important part of the supply chain; origination)
+ purchase dpt at a large consumer goods company like Nestle or Starbucks
+ a sampling / verification company (SGS, Bureau Veritas, etc); these are the guys traders hire to insure that the materials they are paying for thousands of KM away are actually what the contract says.

Dec 27, 2014

Hey guys, can someone tell me what the typical success or transaction fee that one can obtain (as an independent contractor) on any given fee? Is it a % of revenues? Thanks.

Jan 5, 2013
Jason Borne:

Hey guys, can someone tell me what the typical success or transaction fee that one can obtain (as an independent contractor) on any given fee? Is it a % of revenues? Thanks.

Margins are usually razor thin. Volume and sound risk management are your friends.

Dec 27, 2014

While the world international supply chain will always require raw materials -- henceforth commodities, the industry consensus is that the glorious heydays of (aka "commodities supercycle") are gone.
I would argue the industry is experiencing a dramatic change:
- The growth is relatively slowing in emerging markets including China,
- Even though Western banks are divesting and selling out their jewels (see JPM deal with Mercuria), trading houses are getting more and more competitions from emerging market banks (eg BTG) and producers/customers setting up their own trading units.
- It seems like the mainstream strategy is to acquire hard assets and integrate supply chain vertically, in order to get advantageous market information and to gain preferential access to resources. This can't happen without an expanding working capital... bye bye traditional light-assets merchants.

That said, from the perspective of employment, high staff turnover and talent poaching also means attractive packages for the experienced commodities trader.

My two cents.

Dec 27, 2014

It depends on the commodity but generally they are razor thin just like in IB non physical. To give you an idea the agribusiness shop where I work at usually takes 2% of the turnover.

Dec 27, 2014

Thanks, yeah i was actually thinking about agricultural commodities. 2% is a lot, I was expecting less than 1%, considering it's high volume...

Dec 27, 2014

OP: WTF are you even asking?

Oct 26, 2010
contagoman:

OP: WTF are you even asking?

Why the eff, you even care? Traders do not work off set fees, that is sales and marketing.

Dec 26, 2014

OP, physical traders don't make transaction fees. Brokers do.

Dec 27, 2014

Very thin. In recent years, Trafigura, one of the top commodity trading houses, got accolades for its high profitability. A closer look of the business, you would find that even for them, Net Income / revenue is roughly 50 BPS to 1%.

Dec 27, 2014
halfstep:

Very thin. In recent years, Trafigura, one of the top commodity trading houses, got accolades for its high profitability. A closer look of the business, you would find that even for them, Net Income / revenue is roughly 50 BPS to 1%.

On an unleveraged basis...

ROE is sky high....

Jan 3, 2017

how exactly a physical commodity trading house makes money
why there is a need for independent comodty houses, whats there right to exist?

read WSO-PHYSICAL energy trading AND LOGISTICS

Aug 25, 2017

We are looking for a junior person to join our team. We are a Commodities trading company with offices in Europe, US and Asia and the role is within one of the petroleum products' teams. - message me if interested.

Shiptracker Analyst in Oil Industry
A position has come open to join our European distillate team in London as a shiptracker analyst. Role responsibility is to track all ships carrying distillate (diesel, gasoil and jet fuel) across key routes as identified by the team in order to contribute to the global distillate supply and demand analysis. A strong analytical capability and attention to detail are essential, strong computing skills with knowledge of databases, python, VBA and softwares such as Tableau are preferable. This role would be suited to someone who is keen to learn the fundamental market drivers of oil and has a numerate/analytical/coding education and interest, with 0 to 2 years of post-graduation work experience. We are a Commodities trading company with offices in Europe, US and Asia and the role is within one of the petroleum products' teams.

Aug 25, 2017

That's pennies compared to what one metals trader did at Deutsche. Caught earlier this year. Yes, he moved the ENTIRE gold market (and silver) HUNDREDS of basis points. Mindblowing how one guy can affect such a global commodity. Unless, of course, the real actors are using him as a scapegoat.

http://www.zerohedge.com/news/2017-06-02/deutsche-...

Aug 25, 2017

yeah but freeing arms smugglers in Nigeria is some pretty asinine stuff. Imagine if those guns make it to some terrorist's hands.

I'd imagine you'd have to have absolutely no moral compass to succeed in the commodity trading business.

D.I.

Aug 25, 2017

very unlikely to happen at a major in today's times

Aug 25, 2017

elaborate. The director of oil trading at Glencore freeing Russian arms smugglers is pretty shady stuff by even NIgerian standards . I mean in this case it's the Nigerians accusing the other guy of breaking the law !

D.I.

Jan 3, 2017

the 1% chance it happened can become 100%
if it did happen, it is because they had the OK from the secret services.

Aug 25, 2017

Bump

Aug 25, 2017

Not sure, but I think that is referring to their line of credit.

Aug 25, 2017

Just means money available for trade.

Aug 25, 2017

Funds available to trade, including loc, cash, etc...

RedBear

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