Contents - AL-Tax

148 11 Global Trading of Commoditiescontain specified puts and calls. Under this arrangement, buyers typically have theright to call when prices reach a certain threshold, and sellers have the right to putif prices fall below a specified floor; when prices are within the put/call range, thetransactions price is arrived at by mutual negotiation on an annual basis.11.1.3 Core Assets and SkillsA good deal of trading in physicals is customer-based, although proprietary tradingis also fairly common. Traders realize profits, in essence, by creating marketefficiencies and exploiting short-lived price differentials over time and across markets.For example, on customer-based business, traders engage in time and locationswaps, thereby eliminating the need to store and transport product. Through theircomprehensive knowledge of infrastructure and their ability to manage risk, they arealso able to move product more cost-effectively than large and less nimble producersand consumers when called upon to do so. By maintaining stocks of certain metalsin particular shapes and qualities in various locations, traders are often able to meetspecialized demand quickly, and sell metals at higher prices than the prevailing LMEprice. Proprietary trading generally entails making markets and earning a bid/askspread, taking positions and taking advantage of arbitrage opportunities.There are a number of key prerequisites to successful physicals commoditiestrading: (1) access to financing; (2) access to product; (3) a reputation for reliability;(4) a set of administrative controls that prevents enormously costly errorsand facilitates the effective management of risk; (5) a sophisticated IT system thatenables traders and risk managers to track activity in real time; and, (6) expertise inmarket fundamentals, trading strategies, risk management and market infrastructureand logistics. In some markets (e.g., natural gas and power), traders possess all ofthese forms of expertise. In other markets (e.g., copper concentrates, alumina andfuel oils), a separate group may have the necessary logistical expertise.11.1.3.1 Access to FinancingAccess to financial capital is a pivotal element of all trading companies’ operations.The importance of financing varies to some degree, depending on the type of transactionand the commodity at issue. For example, significant financing is essential instructured finance, where producers are capital-constrained, and in alumina markets,where product is traded in very large volumes. In contrast, certain types of preciousmetals trades require substantially less financial capital by virtue of the way thatthey are structured. However, with very few exceptions, access to substantial linesof credit is a sine qua non of commodities trading. Commodities trading firms generallyrely almost entirely on European bank lines. European banks have a muchgreater understanding and appreciation of the complexities of commodities tradingthan U.S. commercial banks, and have not exited the business, as U.S. lenders have.Bank loans can be grouped into three categories: (a) structured finance;(b) working capital; and, (c) repurchase agreements. Structured finance is providedpredominantly to the European (most often Swiss) offices of trading firms. This