Posts Tagged ‘Physical traders’

Physical Traders: Fiscal regimes for international petroleum agreements (IPAs)

Law OilMost of the jurisdictions posses a set of legal tools to deal with responsibilities of the oil field developer (further designated as lesee) and the owner of mineral rights (lessor), as mentioned in previous post usually a government. Agreements, as a whole called fiscal regimes for international petroleum agreements (IPAs) became synonymous with the financial “split” between the two parties over the life of the oil project. We can discern following most typical categories of international petroleum agreements:

Concession (Royalty Tax system)

With the oldest history reaching a XIX century. The lessee is guaranteed to produce and trade the oil in any way he wishes in exchange for a royalty paid to the lessor. Lessee remains liable for corporate income taxes and sometimes special oil and gas taxes. Oil company takes a title to the wellhead, provides capital for exploration, development and production. Royalty being paid by an oil company to the lessor (typically government in a given country) is usually a percent of a revenue (price for which physical oil is being traded).

Production Sharing Agreement (PSA)

Also described as production sharing contract (PSC). For the first time introduced by Indonesia in the 60’s. The difference from Royalty Tax System is that the lessor (typically government) retains partial ownership in the physical oil produced. The PSA divides oil produced to cover the costs of development and production (cost oil) first and allocates remaining residual oil (profit oil) to be split between the lessor and the lessee. These contracts tend to have a very complex structure, concentrating on covering all aspects of costs, rates of cost deduction, and et cetera that limit the compensation of the company before the lessor gets his share (so-called takes).

-company has property shares title
-leese splits exploration, production, development capital with a lessor
-oil company pays no or low royalty
-there are usually limits on amount of capital and operating cost deemed deductible per year
-company pays government CIT and special oil taxes

Risk service contract

Could be classified as transactional services agreements. In short, oil company provides development, production and transportation services to the lessor in return for an agreed upon dollar per barrel rate.

- oil company remains only a contractor with no rights and title to physical oil and provides little or no capital.
-pays no royalties
- but still pays taxes 

Acquiring and managing the rights to exploration has become a business in itself. Very often, the real value lies in the information and knowledge about the given physical oil properties. Many title owners have monetized this value through exploration lease auctions.

Physical Trader Blog

Physical Traders: Access to physical oil

Contrary to popular belief, accessing new oil reserves does not only depend on available technology and thorough seismic analysis, but  also involves great amount of dealing with laws, regulations, leases, auctions and permits issued and mandated by governmental bodies. It is also about establishing and managing partnerships, negotiating deals,  drafting complex contracts and considering a variety of geopolitical issues.

Oil field development could be broken down into following steps:

1.Localization of oil field

2.Acquiring legal access to exploration and development

3.Appraisal data generation and its subsequent analysis

4.Project finance and establishment of contracts for production output

5.Final investment decision  signifying a commitment on the part of the company involved

6.Field development

7.Field production

Despite the fact, that these points outline the whole process, the reality is more complex. It becomes increasingly difficult to operate for independent E&P (Exploration and Production)  companies. With the maturement of the industry, unexplored  areas of land are becoming more scarce. National Oil Companies on the other hand became more aware of its weight in this business, and hence less likely to share title to reserves.  Nowadays, E&P companies are much more prone to acquire new reserves through acquisition or partnership  than geological search. New discoveries made by geological search are bound to happen in offshore areas, where costs of exploration  are very high and access to the best technologies  is necessary to make an oil exploration cost-effective.  These “entry requirements” are limiting such exploration process to largest International Oil Corporations.

Exploration and Production companies are also pressed more than ever  to work closely with National Oil Companies to be able to access the already discovered oil that is there to be developed.

The right to explore and develop relates to mineral or subsurface rights which around the world are usually held by a state government (with an exception of US and Canada). However local communities, private owners of land under which physical oil reserves are situated are also important stakeholders not to be taken lightly in the process.

Find out about physical commodities trading companies.

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Physical Traders: Friday oil quotes

Physical trade3Since weekend is approaching, I decided to present a compiled list of oil related quotes to your appeal (great cocktail party resource for every physical oil trader):

“Oil is like a wild animal. Whoever captures it, has it.”

(John Paul Getty, billionaire, founder of Getty Oil)

“Drill for oil? You mean drill into the ground to try and find oil?
You’re crazy.”

(Drillers Edwin Drake employed for his projects in 1859)

“Exploration for oil always costs money; production of oil always
makes money.”


“If you’re only going after elephants, you’ll never hunt.”

(Ali Moshiri, president of Chevron Africa)

“No matter what the production was or what the hopes of the producer
are, death and destruction surround that field, and it will only be a
year or two at the most, when it will be numbered with last year’s
snows and forgotten.”

(From a 1905 report to Standard Oil from
Colonel Carter of the Carter Oil Company
about the Kern River field; 105 years later
the field’s cumulative production
has passed 2 billion barrels.)

“What is worse than drilling a dry hole? Finding gas.”

(Wildcatter’s lament)

“It should be remembered that oil is not an ordinary commodity like tea or coffee. Oil is a strategic commodity. Oil is too important a commodity to be left to the vagaries of the spot or the futures markets, or any other type of speculative endeavor.”

(Saudi Arabia Finance Minister, Sheik
Ahmed Azaki Yamani)

“Kilometers are shorter than miles. Save gas, take your next trip
in kilometers.”

(George Carlin)

Physical Trader Blog


Physical Traders: Coffee, biggest price gains in 19 years

physical tradeDraught in Brasil has caused coffee prices to fly high. High temperature with low chances for rain in upcoming days, that is how the forecast for Sao Paulo, with nearby Mogiana region, being one of the major coffee producing regions in the country, looks like. Coffee producers, investors and people involved in physical trading observe how the situation evolves with tension. For some it means gains, for some loses. Draughts that Brasil has been suffering for, already made the prices high. On NYMEX Arabica prices has been up by 44%. These are biggest monthly gains since 19 years! Brasil is the biggest producer of Arabica beans, that is the reason for worries for the loss of quality and quantity of beans to be harvested. If the unsavory weather condition will maintain, the prices are going to remain under demand pressures.

Find out about physical commodities trading companies.

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Physical Traders: Introduction to physical cotton trade

Physical trade cotton

Cotton ready for shipment, 1911

Over 70% of world cotton crop is being produced in countries as China, the U.S., India, Pakistan and Central Asia. Cotton is consumed all over the world, with annual consumption running from over 50 million bales in China to as little as 1000 bales (Armenia and Nicaragua).The largest consumers are China, India, Pakistan, Turkey, the U.S. and Brazil. Majority of the world’s cotton consumption takes place in countries where cotton is also produced. This development has turned former large cotton exporters like China, Mexico, Turkey, India and Pakistan into net importers of the commodity. Quality needs also affect the world trade. In India or Pakistan the textile industry supplies yarn, fabric and apparel to Asia, Europe and U.S. To provide top quality textile products for exports,
local mills relly on imports of U.S. and Australian cotton, which have a very low rate of contamination (what exemplifies a better grade).On the other hand Pakistan and India continue to trade some of their lower grade with less demanding Asian business partners.It is worth of remark that physical cotton trade is not exactly free. One can not sell Chinese cotton to Chinese mills since its goverment affiliates business. Similar situation applies to India. Nonetheless it is possible to freely trade cotton from China and India worldwide, when we come from outside of these countries. Physical cotton traders connect farmers and textile mills, taking a role of a market maker. Being able to buy when farmers are keen to sell, and being able to sell while textile mills are in need to buy. This role is of no small importance. It has much less to do with a speculation, as a general opinion goes. Buying low and selling high. It is basicly a seller market, and a commodity is being bought at the highest price of the day from a producer, and sold at the lowest. Not more than 10 companies worldwide can be considered as leading physical traders. They trade in millions of bales. However there are also family companies on the market, with strong business traditions. Added value physical traders bring into cotton trade is also based on  their ability to buy all quantity produced, buying total quantity harvested on the contracted acres, ability to deliver minimum price guarantee contracts, forward contracting, ability to speak producer language (which is not a small matter by the way), financing and foreign exchange. On the receiving side, added benefits for spinning mills encompass: supplying cotton according to the exact specs, delivering exact quantities,  storing large stocks of physical cotton, selling on forward up to 2 years ahead, maximum price guarantee contracts, providing credit terms with payment, selling with rejection clause, or selection of actual samples, delivering “just-in-time” on the exact requested date/time.

Producers and mills must be able to rely completely on the merchant’s guarantee of performance, in spite of market conditions. With today’s high volatility in prices, this is very important. From this guarantee of performance an importance of trader’s reputation can be directly derived.

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Physical Traders: Freight hedging in physical commodities trade

physical trade2Despite the volatile and cyclical nature of shipping industry, the idea of widespread freight hedging as used by commodity traders is relatively new (going back not much more than a decade). Shipping freight derivatives have the potential to limit freight rate risk of the dry-bulk and wet-bulk sectors. The volatility of freight rates, constitutes a major business risk towards  shipowners and charterers (traders). For the party hiring a vessel for transportation, higher freight rates leads to higher costs. For the shipowner, lower freight rates amounts to less profit from hiring out vessels. Hence freight derivatives provide a real benefit to parties involved, making risk management cheaper and more effective, when compared to other traditional methods of limiting the exposure as a time charter, where shipowner was bound to leave ships to the full disposition of a charterer, what prohibited him to profit from any advantegous spot market opportunities and where time charterer had to face operational risks implied by charter party agreement. Hence both commodity traders (as charterers) and shipowners, can focus on their respective domain and at the same time manage the risk through the separate, paper trade market. This solution is also more cost effective because of the relatively low fees charged by brokers on this market (when compared to shipbrokers) and the easiness of getting out of position when compared to leaving a physical position. Naturally in paper freight hedging there is no physical settlement, the difference on the taken positions is paid out in cash.

For dry-bulk market voyage-based contracts are settled on the difference between the contracted price and the average prevailing value of the route selected in the index over the last seven working days of the settlement month. Time-charter-based contracts are settled on the difference between the contracted price and the average index value over the calendar settlement month. For tankers settlement takes place at the end of the month where the fixed forward price is compared against the monthly average of the spot price of the tanker route selected.

Not only trading houses, employ freight hedging as a tool, but also oil refineries, when taking into consideration their cash-flow management. However according to different sources commodities trading companies occupy up to 40 % of the whole market, so even more than pure financial players. Market participants have to disposition following types of products: OTC and cleared freight forwards, exchange-based freight futures (traded on NYMEX and Oslo based IMAREX) OTC or cleared freight options. So let’s speak a little bit about forwards. Forward Freight Agreement (FFA) are Contracts for Difference between a seller and a buyer to settle a freight rate, for a specified quantity of cargo or type of vessel for one or a combination of the major trade routes of the dry-bulk or tanker sectors. FFAs are custom made what only increases their popularity. In case of FFA as in case of other OTC instruments parties are bound to accept their credit risk. The facilitators are major shipbrokers and financial entities (icluding investment banks). Once again, what is worthwile to remember, OTC gives a lot of flexibility to participants, to draw contracts according to their changing needs and changing business environment. Indices comprising freight rates and reflecting their fluctuation across dry bulk spot voyage and time-charter rates are being used as underliers in FFAs. Here we speak of Baltic Panamax Index, Baltic Capesize Index, Baltic Supramax Index and Baltic Handysize Index. In case of wet bulks underlying indices are: Baltic Dirty Tanker Index and the Baltic Clean Tanker Index. Routes included in the indices are numbered. Vessel size, cargo, route description and weight assigned to the route reflecting its importance in freight market at time of construction of the index are specified. Vessel size is measured in deadweight tonnes and comprises of cargo, bunker, lubricants, water, food and crew. Shipowner is paid in case of voyage charter in US dollars per ton, to get a cargo for a trader from point A to point B. Time-charters are paid in US dollars per day, shipowner is paid every month or twice a month. He operates the vessel under direct instructions from the charterer.

Find out about physical commodities trading companies.

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Physical Traders: Shortly on different types of lending in physical commodity trade

There is as many types of credit analysis, as there are banks. The same relates to credit rationale behind lending in trade finance. The trend has been also emerging since some time already of banks increasingly taking a role as an arranger of financing taking funds effectively from third parties or capital markets. Still, when tackling the question of financing a physical commodity trade we can discern some main approaches relating to the issue of repayment, namely: balance-sheet lending, cashflow lending, asset-backed lending and credit-enhanced lending.

Vast majority of commercial bankers prefers balance-sheet lending approach when assesing a repayment risk. Here a lot depends from dependability of accounting standards in the country in question (commodities trade after all strongly involves dealings with emerging or even frontier markets) and reliability of auditing bodies. However even if both of these factors are acceptable on the grounds mentioned before, financial professionals are aware of the facts that balance sheets are historical documents and that auditor’s judgement might be fallible.

Crudely speaking, the fundamental principle of balance-sheet accounting is that the shareholders funds with everything they can borrow equals liabilities that subsequently uphold the cost of all of the assets of the firm (fixed assets as buildings and mines or the current assets as inventory, receivables and cash in the bank).

As general principle, financiers look at the relationships between certain key items on the balance sheet, to asses if the balance sheet can support current or future levels of debt. Attention is being paid to the ratio of
the shareholders funds (such as equity, reserves/retained profits) and its liabilities, especially the current year portion of debt. There are also other ratios employed, as the quick ratio, leverage ratios, or liquidity ratio.

Banks also look on the valuation of the company’s assets (whether its proper or not), as well as levels of inventory in relation to company’s turnover, so they can see that company’s revenue from trade covers the costs sufficiently to make a profit at the bottom line.

In cashflow lending, financiers strive to identify cashflows of the firm, and then make sure to “put them aside” to get paid before everybody else. If possible even before the costs which company bears. It is a fine approach in commodities business, since certain specialized assets in emerging/frontier markets whose value could have assured an asset-backed lending are difficult to price. Hence in cashflow lending, financial companies seek debtors of company in question or the receivables due from companies of superior credit quality to the borrower. It is also seen as an advantage if they come from developed markets. So here banks secure a cashflow from a purchaser the client is trading. In such situation a creditor gets paid from revenues, not from bottom line profit.

In this scenario the main threat to the lender comes from the borrower’s performance risk. Question is posed, whether the economic activity of borrower will carry on and whether receivables due will keep on flowing. There is also certain structural risk to the creditor depending on how well cashflows coming from sales are going to be secured, so no other creditor may take advantage of them first. Assignment of the export contract is one of the ways, it is being done.

As far as asset-backed lending is concerned it should be to certain degree related to cashflow based lending, with additional physical collateral in place which liquidation should secure a repayment. Therefore the point is to take security over the raw materials and inventory, either in the producing country or offshore. In asset-backed lending a lender controls the collateral. The key issue remains for a lender to perfect his title to the goods. Here it is possible in certain cases to apply a SPV to take debt off the balance sheet. One way or the other in such situations, some banks seek to establish their own collateral management in the field (to dislike of trading houses, who tend to fully rely on their own people/business partners).

The credit-enhanced lending is about someone else possesing a good credit rating guaranteeing all or part of the facility. The role of third party guarantor is often being taken upon by Export Credit Agencies, whose role is becoming increasingly difficult because of pressures from home governments to make money on one hand and to back up trade with the high risk countries characterized by high default ratios in support of political agendas on the other. The credit enhanced lending also includes credit wraps and political risk insurance, where banks and traders decide for a commercial underwriting of the transaction. Naturally it generates further expenses and is possible to implement only when the deal is structured in a way that is acceptable to the underwriter.

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Physical Traders: Trade finance in physical commodities trading, approaching financiers and negotiating better terms

Physical trade 6Realizing how important part trade finance plays in physical commodities trading, I would like to write shortly about the factors banks and financial boutiques pay attention to when financing cross border commodities trade. Knowing the key factors makes it possible to adjust them within the limits of our business according to the expectations of financiers. Here I will start with the basics and in following articles on this blog I will strive to elaborate on more complex issues trade finance is concerned with, such as structured trade and commodity finance.

There is no better argument when negotiating advance financing than a proven track record. What we need to show is that we have done it before. That we have been in business, and that we have a capacity to deliver. How can we do this? Simply by presenting financial track record or our bank statements showing the incoming and outgoing cashflows.

Another important thing when we look for advance financing is to prove to the bank that we are not going out of business any time soon. One of the ways to prove it is to show that we are profitable, that it is not in our interest to back out when they open a Letter of Credit for us. Banks also may want to know about the state of our tax affairs and on how we handle our situation with other suppliers. If everything is in order in these departments, we are in stronger position to negotiate the more advantageous terms.

Presenting a credit history is mainly a significant factor because of the insurance banks seek to apply to such transactions. They can present our credit history to their underwriter and get better terms, what implies better terms for us.

It also works good to start small with our new financial partner, build trust and reliance on smaller trades and slowly proceed towards larger ones. So it is not only about our track record, but a track record with a given financial partner.

If our trade financing relies on existing purchase order, it is beneficial if our buyer is ready to communicate with our financial partner. So the prove of the purchase order is not only a document issued, but that there is a direct assurance from the side of our buyer, even if not contractual one, to perform.

Find out about physical commodities trading companies.

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