Understanding Commodities Pricing
An Overview of Commodities Markets, Transactions and Price Types
Commodities play a vital role in the global economy as essential resources used in the production of goods and services. The global commodities market, estimated to be worth trillions of dollars annually, fuels economic activities worldwide, acting as a cornerstone for industries ranging from manufacturing to agriculture, energy, and construction.
In the intricate realm of commodities, the market operates through various types of contracts and pricing mechanisms, attracting different types of market participants.
In this article, we will present the fundamentals of commodities markets, key market participants, the different types of contracts and prices involved. At the end, we comment about possible sources of commodity price assessments, highlighting key differences between traditional companies that provide such information (e.g. Platts, Argus, ICIS) and newcomers such as Intratec Solutions.
What are Commodities?
In economics, commodities refer to economic goods, typically resources, that possess substantial fungibility. This means that instances of the same commodity are treated as equivalent regardless of their origin.
Commodities are predominantly utilized as inputs in the manufacturing of finished goods, while the term “product” denotes the final goods sold to consumers. A crucial aspect of commodities is the minimal differentiation between the same goods produced by different entities.
Commodities Markets and Players
Commodity markets involve different types of players, including producers of commodities, consumers of commodities, and speculators or traders. These players interact and transact in the market through various contracts and prices.
Producers and consumers of commodities participate in physical markets, where buying and selling interests converge to address supply and demand imbalances, taking into account the available inventory levels. These markets facilitate the immediate delivery of commodities, and the price at which the commodity is readily available for delivery is known as the spot price.
On the other hand, futures markets serve the needs of end users who want to make choices about the future. They allow these users to trade their expectations about supply and demand patterns, which mainly focus on changes in inventory levels over time. In the futures market, participants engage in “risk transfer” by speculating on the future price movements of commodities.
Commodity Transaction Types
Amid this backdrop, where different players may interact in both physical and futures markets, there are different ways to make transactions involving commodities, briefly summarized as follows.
Long-Term Contracts. These contracts usually refer to long-term relationships, in which the commodity is regularly delivered over months.
Spot Transactions. Differently from long-term contracts, spot transactions concern isolated transactions for prompt delivery, in which transaction terms (prices, quantities, deliveries) are negotiated for that specific transaction only.
Future Contracts. Futures contracts refer to standardized agreements to buy or sell a specific quantity of a commodity at a predetermined price on a future date. They are traded on exchanges and may serve as a means of managing price risks. Futures contracts are widely used for speculative purposes as well. Producers and consumers can utilize futures contracts to hedge against potential price fluctuations. Speculators, on the other hand, take positions in futures contracts based on their expectations of future price movements.
Commodity Pricing
Different transaction types result in different commodity pricing. Main differences among commodity prices are presented below.
Long-Term Contract Prices. Long-term contract prices are usually based on the supply and demand balance at the moment of negotiation. However, such contracts are usually valid for 10 years. Therefore, seller and buyer agree on correction indexes that will be used to periodically adjust the price over the years, in such way to mitigate risks for both parties. Therefore, as time goes by, some contracts may stipulate prices that differ from current market conditions.
Spot Prices. Spot prices reflect the prices at which the commodity can be purchased for immediate delivery. Differently from contract prices, spot prices are ruled by the current availability of the commodity in the marketplace — the lower the availability, the higher will be the commodity price. Therefore, they can be highly impacted by shocks such as plant shutdowns, natural disasters or supply shortages due to any other causes. On the other hand, low demand and higher producers’ inventories will lead to lower spot prices.
Future Contracts Prices. The future contracts prices actually reflect the market agents expectations for supply and demand balance at the future date approached by the given contract. It is usually very difficult to predict the price of a commodity many months ahead. Therefore, many suppliers and consumers use future contracts as a strategy to mitigate risks and better manage the price at which they will sell or buy the commodity in the future. On the other hand, traders and speculators take part in the market, aiming to make profit from the difference between expectation and reality.
Volume-Weighted Average Acquisition Price. The Volume-Weighted Average Acquisition price (VWA) reflects an average price of concluded negotiations in the acquisition of commodities in large quantities. It does not represent specific long-term contract prices or spot prices, but rather it is a volume-weighted average of the prices at which transactions were closed in a given period of time. Such negotiations typically occur by maritime transportation, between locations of great influence in commodity markets.
In the universe of commodities market, commodity purchasers typically have a specific sourcing strategy that suits their needs and conditions. That strategy usually comprises more than one kind of transaction, where part of their supply needs is guaranteed by long-term contracts, while the remainder may be acquired in the spot market or even through future contracts.
Therefore, when assessing the raw material costs of a producer, for example, using either contract or spot prices as the raw materials price assumption may lead to wrong conclusions. The VWA price represents a better indication of the average price at which a producer actually acquires its raw materials.
Commodity Price Data Sources
Commodity prices may be obtained from different sources, including commodities exchanges; financial news websites, government agencies. Companies may also provide commodity price assessments.
Commodity price information services are typically provided by companies referred to as Price Reporting Agencies (e.g. Platts, Argus, ICIS). The conventional practice of such companies involves weekly phone calls to commodities sellers and buyers to ask the prices settled in their most recent transactions. Based on the different answers, such companies come up with the conclusion of how price is going to behave.
Newcomers such as Intratec Solutions take an alternative approach to provide commodity price data. Instead of relying on opinions of some market participants, Intratec uses only data from auditable sources, mainly official trade statistics released by national institutions, to produce reliable commodity price assessments.
About Intratec Solutions
Intratec Solutions — Independent Commodity, Energy & Industrial Intelligence. In operation since 2002, Intratec turns complex commodity and industrial data into clear, comparable intelligence. Its AI-enabled products cover prices, market dynamics, production economics, and the broader conditions that shape competitiveness. More at intratec.us.