Welcome to the third edition of Hot Commodities.
This bi-weekly newsletter uses the PanXchange team’s experience and knowledge in physical commodities to bring you perspectives on what’s happening in the elusive, opaque domestic and international markets. And, of course, we're going to keep you up-to-date on blockchain -- what's working, what's practical, and what's downright lunacy.
LNG market evolution
Interesting developments in market structure evolution for global LNG trading in the past two weeks. JERA – the joint venture of Tokyo Electric Power Co. and Chubu Electric Power Co, and the largest global buyer of LNG – slashed an offtake agreement with Abu Dhabi Gas and Liquefaction Company. A week later, the firms announced a newer, shorter-term supply agreement entailing eight cargoes, up to 0.5 million tons per year over three years (the previous contract term was 25 years of 4.3 million tons per year). The newly written deal is in line with the 2017 Japan Fair Trade Commission ruling calling LNG destination restriction clauses anti-competitive. This ruling and new contract are real time examples of the PanXchange commodity market evolution hypothesis (we’re working on a white paper – it’ll be great beach reading).
New commodity markets are initially priced with long-term offtake contracts in order to finance development of the physical assets, providing financiers with some insurance on investments. As markets develop and more players enter the field, the term contracts are less attractive to both sides as long-term price forecasts are not only difficult but almost always wrong. From this point, a smaller percentage of sales are through term contracts, the terms are shorter, and the balance volume is traded on spot markets for more transparent price discovery. As spot market hubs become more standardized and liquid, new players and traders enter the market looking to take part in the risk.
Simultaneously last week, sources revealed that Goldman Sachs is in talks with Cheniere Energy, owner of the Sabine Pass LNG liquefaction and export terminal on the border of Texas and Louisiana, to buy a cargo of physical LNG. Most banks backed off physical commodity assets and trading in 2015 as new rules from the Fed tightened regulations on banks to prevent excess risk in case of the financial fallout from, say, an oil tanker spill. This appetite to get back into physical trading, particularly LNG, demonstrates developments of a strong spot market.
“Speculators” often get a bad rep, but for a successful physical market there needs to be traders in the middle. A liquid physical market will close the basis differentials and arbitrage opportunities, maximizing economics and narrowing the spread on spot market hubs.
Phew. That was heavy.
Let’s get to the fun stuff: Sand!
If you missed our first two editions and are wondering what frac sand is, check out this video.
…oops, wrong video, click here for a quick video explaining the whole frac sand process.
Frac Sand Update
Here’s a snippet from our weekly update:
"We are seeing more and more arbitrage opportunities appear in the market, particularly for those with higher priced contracts in place and last mile solution offerings. We would not be surprised to see sand companies actually appear as the primary bid in the market in the near term, potentially repurchasing distressed spot sand at lower pricing, in order to gain more contract coverage..."
So, what does this actually mean? The sand market has followed a somewhat similar trajectory as LNG. Booming demand and shortage of supply caused high prices, which in turn spurred a huge amount of investment in new sand production capacity. These new mines, many focused around the Permian basin in West Texas due to proximity to one of the hottest oil plays in the world and lots of available sand, required offtake contracts for financing. Service companies and operators were happy to sign the deals as many were on the verge of shutting down completion activity due to the shortage.
Fast forward 5 months, and all the new supply from these mines is now flooding the market and prices have tanked. Oil and gas takeaway capacity (pipeline space) is maxed out and completions are slowing (albeit from breakneck speeds). The price of spot sand is now below some of the term contracts.
So how could a commodity trader play this? Sand producers are short sand through the term contracts. The price of spot sand is below the cost of the term contracts plus transportation. The producers could buy on the spot market to deliver on their contracts, profiting without even touching their producing assets and putting more supply on the market. Now this is a massively oversimplified example, and the real world doesn’t always work like a excel formula.
But for now, this is an insurmountable mindset shift and demonstrates that there’s much more development to happen in the spot sand markets. But there’s a lot of arbitrage opportunity for the traders who recognize the play.
Deconsolidation in Cocoa Markets
After a series of exits, bankruptcies, and subsequent fraud allegations of larger tradehouses in the cocoa space, smaller, more nimble shops are picking up the slack. The majority of cocoa is produced in Africa, with over half of the total global production in Côte d'Ivoire and Ghana. Smallholder farmers produce much of that total. (see aggregated production data below).
Physical trading in African nations is a tough endeavor, with few effective trade associations promoting rules and standards, and slow-moving, ineffective, sometimes corrupt courts making contract enforcement difficult. Until these underpinnings of a formal trading environment develop, tradehouses must be able to work with farmers and traders in a volatile trading environment. Defaults and associated risks exacerbate price swings and cause trouble throughout the supply chain. These wild west aspects of the cocoa markets are also reasons why margins are significantly better than larger commodity markets in developed nations.
While some of the majors are pulling out, other large traders with physical assets like grinding facilities still have a large market share; Cargill still grinds around 800,000 ton per year. Will this deconsolidation level the playing field, or just create a larger group of smaller buyout potentials?
The good news? Cocoa prices have fallen by over 20% since highs in April. 95% ultra-dark lovers shan’t worry about getting their fix.
Metals Throwing Mixed Signals
Copper and steel are telling two different stories for metals both caught up in the global trade war and both watched as indicators for economic growth. Copper was down around 20% from June to July, while steel was up 16% over the same period. So, who’s telling the true story on growth? Neither, really.
Excellent commentary from Andy Home, link below.
IBM and Maersk announced that their project TradeLens, a supply chain information platform, grew to 92 participants using or agreeing to use the system. The permissioned, private blockchain system has so far written over 154 million shipping events, like shipping documents clearing and container weights, to the ledger.
The cooperative effort now comprises Hamburg Sud, bought by Maersk last year, and Pacific International lines, which account for more than 20% of the shipping market. This is one to watch.
Blockchain has hit the government scene! Voting in West Virginia will now happen:
On an app.
On a smartphone.
On the blockchain.
Talk about secure!
Forgetting the blockchain piece, the amount of vulnerabilities present in the system of voting that uses mobile phones, over a cell network, combined with an app cannot be overstated. Add in the blockchain – every week, developers continually discover new vulnerabilities in cryptocurrency software, the only market with widespread application of blockchain technology – and the vulnerabilities are staggering.
As always, there’s a relevant XKCD: