Commodity Trading center: China’s Role and Proposition


The business of commodity trading has grown dramatically over recent decades. This paper outlines the underlying reasons for this growth, the vital role commodity trading plays in the global economy and the benefits this brings to participants and the wider society. It details the nature of commodity trading activities and explains how they are typically organised to achieve greatest effectiveness. Along with the rise in Asia’s share of commodity production and consumption, the paper provides further insight on the role and benefits of commodity trading center within the region and China’s prime position to support the needs of growing economies across Asia.

 

Commodity trading plays a vital role in the global economy

Each year around US$10 trillion of commodities are produced and consumed . However, commodities are rarely produced and consumed in the same place or at the same time - a complex value chain including refining, processing, storage and shipping is usually required to get them to the right place.

 

Linking these value chain elements together is commodity trading. Commodity trading enables the transition of commodities from the mine or field gate to the factory door and end consumer. Commodity trading ensures the right product turns up in the right place at the right time and at the lowest cost. Commodity trading helps make markets more efficient and reduce business costs.


Different ways for industrial companies to participate in commodity trading 

Industrial companies that produce or consume commodities can participate in commodity trading in different ways. At its very simplest, commodity trading is selling when the commodity is ready for sale or buying when the commodity is required for consumption. However, many industrial companies are more sophisticated than this and look to both plan ahead and improve margins through commodity trading.

 

Companies can choose from a range of commodity trading models. The choice of model is driven by a range of factors including the companies’ broader business model (including size and complexity of their product flows relative to their overall industrial activity) and their risk appetite (e.g. some companies have minimal risk appetite and use commodity trading to hedge out as many risks as they can whilst others have high risk appetite and use commodity trading to enhance expected returns). It is important to note that commodity trading is not only about margin improvement, but also risk management.


Figure 1 shows the most common trading models, arranged by level of sophistication.          Figure 2


Why companies organise trading activities in centralised units

 

Commodity trading is distinct from the industrial activity of commodities firms. It is complex and has a different economic model and different risks that need managing, therefore requires different types of skills. These skills can be grouped into four activities as shown in Figure 2. These activities are interlinked and need to be located together to ensure the swift processing of time-sensitive commodity transactions.

 

For that reason many companies put their commodity trading activities in a standalone unit, forming a centre of excellence that pools skills across trading, marketing, logistics and risk management. Centres of excellence are often located in commodity trading region.


The role of commodity trading center in Asia

 

Asia’s share of global commodity production and consumption is rising and more commodities are being traded during the Asian time zone. Figure 3 below highlights the commodity asset classes that are now predominantly produced, consumed and traded in Asia (e.g. over two thirds of major commodities like coal and steel are now produced, consumed and traded in Asia). Even other commodities that are predominantly produced outside Asia, like crude oil and liquid natural gas (LNG), are seeing an increasing share of trading in Asia.


Commodity trading center in Asia have an important role to play in developing the market liquidity of these ‘Asian’ commodities


China is helping to improve liquidity in the Asian commodity markets. That adds value for everyone as commodity costs are reduced, supply security is increased and better risk hedging options become available.