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Commodity Trading and Risk Management

Trading goods and commodities is as old as humankind. What's changed, however, is the speed at which new commodity markets and segments emerge and mature.

Many commodity players, especially asset players, experience a significant impact on their businesses when markets change from a classic B2B into a competitive openly traded commodity market. The resulting price transparency leads to an erosion of market premiums, and opportunities to arbitrage start to deteriorate but not vanish. Those phenomena can be seen across all commodity markets—energy, oil, metal, and agriculture. Nevertheless, it’s still possible to extract value from prevailing market imperfections. Also, in mature markets, it’s possible to benefit from trading opportunities as long as players understand how to leverage their competitive edge.

Players entering a traded commodity market, or a market that’s become more competitive, need to identify how to create value as well as tailor a suitable operational platform that matches their trading approach.

Commodity Hubs and Exchanges

Regardless of the maturity of commodity markets and segments, hubs and exchanges professionalize the way trading is conducted. A successful launch allows trading parties to hedge their exposure and needs.

Across different commodity markets and segments, not all hubs and exchanges prove to be successful. It’s the nature of the commodity industry that hubs and exchanges survive only when they provide distinct value in terms of price transparency, liquidity, and effective infrastructure. 

When launching and developing hubs, platforms, or exchanges, players often underestimate how crucial it is to properly address the key success factors to ensure a hub that attracts large traded volumes.

Enterprise Risk Management

Change is inherent to the commodity industry. There are many potential triggers for change—disruptive events, gradual changes in the underlying market fundamentals, and regulatory action. 

Adversely affected market players often aren’t prepared, and they adapt their business and operational model too late. Enterprise risk management (ERM) should help top management detect and prepare for such changes as quickly as possible. 

Almost all commodity companies have an embedded ERM function in their organization. Unfortunately, it’s often perceived as a bureaucratic entity that doesn’t deliver added value. 

ERM mustn't become a dull sword—it always needs to be sharp to help companies to prepare for gradual or sudden changes in market fundamentals and the way other players operate. By avoiding typical pitfalls and refocusing the effort of risk management away from being a compliance function, ERM can become a truly helpful tool for management again.

Trading Systems and IT

Commodity trading systems have lacked maturity. In the past, they were used in a noncost-driven business, which led to the need for very specialized IT units to support them. Shrinking trading margins and increasing maturity of solutions have changed the challenges for trading IT, resulting in a rethinking of past approaches.

Energy & Environment

Eric Boudier on Commodity Trading and Risk Management

BCG’s Eric Boudier discusses the importance of commodity trading and risk management.

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