In an era of volatile resin prices, trading commodities futures for plastics may be an idea whose time has come. On May 27, the London Metal Exchange (LME) will officially launch two futures contracts for "barefoot" (no additives) PP and LLDPE. The LME is using its experience in nonferrous metals to provide a risk-management tool for plastics buyers and sellers.
"Futures" are a contract to buy a certain amount of a commodity at a set price on a fixed date in the future. It is a bet on what the price of that commodity will be at a future time. Futures contracts can be traded just like stocks up until the time they are due.
Plastics futures were developed by LME's Plastics Committee, which includes representatives of Basell Polyolefins, BP Chemicals, Dow Chemical, and Nova Chemicals. Contracts will be offered for a 12-MFR general-purpose injection molding PP homopolymer and a 0.8-MFR general-purpose butene-copolymer LLDPE for blown film and blending. Both contracts will be tradeable every month for 15 months forward and the contract size will be 24.75 metric tons (about 54,564 lb) per lot.
Polyolefin resin producers appear to be cautiously supporting this new service, although most sources were reluctant to be quoted directly. At the K 2004 show in Dusseldorf last fall, Basell's president and CEO Volker Trautz noted that LME's efforts to establish plastics futures trading has the potential to improve the industry's ability to cope with the extreme volatility in PP and PE pricing. "The futures market could provide a credible risk mechanism within the plastics supply chain that would benefit both producers and consumers of polyolefins."
In its participation in LME's plastics committee, Basell and others stressed the importance of creating a real link between the financial and the physical markets. Says a source at BP Chemicals, "I would say we are all in a watch-and-learn mode. We have done some groundwork. Suppliers and processors have discussed how this would be beneficial, since it will only involve one grade for each resin family, which not everyone uses. In the case of PP, for example, processors of impact grades could use the price of the 12-MFR homopolymer to make a good hedge on the grade they want."
A source at Nova Chemicals comments on this idea of hedging prices on specialty PE grades based on commodity-grade futures: "The farther you get from the basic futures grade in terms of the specialty grade you are interested in, the more risk you take in hedging. It is true that when commodity PE prices are rising, the specialty grades move up along with them. But when commodity PE prices are going down, the specialty grade prices usually don't."
Some polyolefin suppliers are not likely to support this futures launch, while others—even Basell's Trautz—feel that current conditions are not ideal due the tightness of both PE and PP, which would make supply assurance more difficult. Says Trautz, "It is important that there is a fully functioning spot market in these materials"—which is not the case when resin is tight.
ExxonMobil Chemical, for one, is not interested in participating. Says a company official, "We do not believe that employing this approach would add any value to the relationships we have with our customers, nor do we encourage any third-party intervention in the relationship with our customers. ExxonMobil does not commonly or materially employ this type of practice."
Most industry sources agree that the support of resin producers and processors is not as essential to success of the new plastics futures as is the support of financial intermediaries and the investment banking community. Says the BP source, "The liquidity will depend on these people, who account for at least 70% of the participants in commodities futures trading. There doesn't have to be an actual physical market, as most of these folks do not want to take delivery of the product."
The Nova source says only 1% of all commodities futures contracts result in delivery of product. He sees it as similar to existing price-hedging services for plastics, which have not proved popular. "Processors are not likely to want to pay for the contracts. Also, longer-term price hedging may not work out for suppliers or processors if market prices rise or drop significantly. Right now there is a huge natural-gas futures market, but it doesn't mean that 12 months down the road, the price now being hedged will pan out."
Advantages of futures
A futures contract provides industry with a method of managing price risk and the ability to lock in an attractive sale or purchase price for a given period, regardless of price volatility, according to the LME. This is essentially a paper transaction carried out by a company's finance or risk-management department. Any physical purchase or sale of raw material would continue as usual via existing channels.
Sources at LME say plastics futures will not create a new middleman and will not change relationships between resin suppliers and processors. Physical delivery of plastics contracts will be typically only a last resort when there is an interruption to normal supply. In the case of metals futures on the LME, less than 1% of all contracts go to delivery. But the reality of potential delivery creates convergence between futures and the physical price.
LME views the introduction of organized futures trading as a way of making it easier for banks, pension funds, hedge funds, and other members of the investment community to enter the polymers market. This means that there will be a balance of financial participants who do not have a direct interest in producing or consuming plastics and industrial participants who do.
LME sources note that financial speculators play an essential role because they bring additional liquidity to a futures market, thereby helping industry to hedge effectively. Hedging is the process of transferring risk to another person, and generally it is the speculator who is prepared to take on the price risk.