Contents - AL-Tax

150 11 Global Trading of Commodities11.1.3.3 Trading, Risk Management and Logistical ExpertiseTraders provide essential expertise in formulating and executing trading strategies,as clearly indicated by their very high compensation levels. An intimate knowledgeof the fundamentals that drive individual markets is obviously part of this expertise,but it also often requires an equally extensive knowledge of infrastructural elementsof the market, which may create trading opportunities or preclude certain tradingstrategies at different times. With respect to certain commodities (e.g., electricity,as well as natural gas), traders possess knowledge of both market fundamentals andinfrastructural and logistical features.However, when product is moved via ocean-going vessel, as is true of aluminaand aluminum (as well as liquified natural gas), the chartering function is generallyperformed by a separate group within the trading firm. The chartering of vesselsrequires specialized knowledge regarding the optimal means of shipping differentmetals and bulk raw materials, how quickly one can load, how long the voyagewill be, the identities of charter parties and ship owners seeking particular cargosizes, the availability and locations of ships at specific points in time, which vesselshave excess space on particular voyages, discharge rates and depths at individualports, demurrage charges, etc. In general, local knowledge is extremely importantin obtaining the requisite shipping capacity at reasonable cost. 3,4 When trading andlogistics are handled by separate groups, traders are in frequent contact with individualsresponsible for chartering vessels, requesting quotes multiple times daily.Shipping rates may determine whether a contemplated trade will be profitable.While traders typically determine their individual transactions-specific hedgingstrategies, the trading group also performs a higher-level risk management function,which is often centralized. This activity entails establishing credit and position limits,continuously monitoring the group’s exposure, and assessing the potential lossesassociated with adverse price movements and changes in spread (the differential invalue from one month to the next).11.1.3.4 Administrative Controls and IT SystemsBecause of the large dollar value of individual contracts and the very high cost ofpotential errors, omissions or missed trades, an effective system of firm-wide controlsis essential. Trading firms generally require that every contract for the purchaseand/or sale of product be approved in writing from a credit standpoint as part of such3 Chartering teams generally work with brokers. Chartering brokers possess important marketinformation that they develop and maintain through daily dialog with other market participants.It is also frequently advantageous to have a middleman in negotiations with vessel owners.4 The freight market is a commodity market, with many characteristics in common with other suchmarkets. Freight rates move on a daily basis, and a futures market for freight (the Baltic Exchange)has developed to provide ship owners and firms leasing vessel space a means of hedging theirexposure. However, only ships of certain sizes are covered on the Baltic Exchange; smaller vessels,constituting the “Handy Market,” are not covered. Some trading firms have “gone long” on ships(i.e., purchased vessels) in recent years, as freight rates have increased dramatically.