Page 4 - MEX Express - Vol 7 Issue 2

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Customers of the Crude Oil Market
Oil production is presently wide spread across the globe. Most of
the oil used today is extracted within the OPEC area, consisting
of countries in the Middle-east, North and West Africa. The majority
of oil is extracted via traditional sources i.e., primarily oil wells on prices. Due to the excess demand of oil, prices are higher than marginal
land. There are also some oil-rigs at sea, especially in the North Sea
and Mexican Gulf. A very small part of the produced oil comes from
alternative sources, such as oil sand. Alternative extraction methods
are more expensive than traditional oil wells, but still they are
profitable during high-price market conditions. Capital intensity of
production is often very high, due to the need of advanced equipment
and infrastructure to procure oil from large depths. Thus, the most
risk exposed customers are the producers, wanting to lower capital
risks. The incentives for decreasing risk are in principal the same
as for producers on electricity markets. The similarities, however,
diminish when it comes to supply and demand. Supply changes have
by far fallen short of demand increments, which have caused prices
to increase to levels higher than marginal cost of production. Even
though the producers are the best beneficiaries, the market has been
inverted.
Due to high volatility in oil prices combined with the on-going
Commodity Market & its Challenges
In a simple language, a physical or virtual marketplace for buying,
selling and trading raw or primary products is commodity market.
In other words, commodity market is a reasonably interchangeable
good or material, bought and sold freely as an article of commerce.
Commodities include agricultural products, fuels, and metals and are
traded in bulk on a commodity exchange or spot market. Commodities
are hard assets ranging from wheat to gold to oil. Since there are so
many, they are grouped in three major categories: agriculture, energy
and metals. Agriculture commodity includes, such as sugar, cocoa,
and coffee and Grains, such as wheat, soybeans, soybean oil, rice,
oats and corn. The energy category includes crude oil, natural gas,
and heating oil. Metals include mined commodities, such as gold,
copper, silver and platinum. Commodities are traded by dealers on
an open exchange. That means the prices change every day. This
can be difficult for the consumer, who must face price variations in
everyday products such as gasoline, gold and grains. The highest
volume of trading occurs in oil, gold and agricultural products.
There are numerous ways to invest in commodities. An investor can
purchase stock in corporations whose business relies on commodities
prices, or purchase mutual funds, index funds or exchange-traded
funds (ETFs) that have a focus on commodities-related companies.
The most direct way of investing in commodities is by buying into
a futures contract.
In business, commodities can be defined as any good or service
that is bought and sold purely on price. These include the traded
commodities, but can also include products that are not very
differentiated from others based on brand, benefits or other
distinguishing features. For example, Coca-Cola is a branded
product that receives great loyalty, and a higher price, because of
its perceived differentiation from other cola drinks. A low-cost store
brand is more of a commodity, because it isn’t much different from
other store brands and is bought primarily because of its low price,
not its taste.
Commodity Market in Nepal
Markets for futures trading were developed initially to help
agricultural producers and consumers manage the price risks they
faced during harvesting, marketing and processing food crops each
year. Today, futures exist not only on agricultural products, but also
in a wide array of financial, stock and forex markets.
In the 21st century, online commodity trading has become
increasingly popular, and commodity brokers offer front-end
interfaces to trade these electronic-based markets. A commodities
broker may also continue to offer access to the traditional pit-traded,
or open-outcry, markets that established the commodity exchanges.
In Nepal, three commodities exchanges — Commodities & Metal
Exchange Nepal Ltd (COMEN), Mercantile Exchange Nepal
Ltd (MEX) and NDEX — are working to provide investment
opportunities to around 2,000-3,000 people. The majority of
transactions of community exchange are in gold and crude oil,
products not produced in Nepal.
In Nepal, commodity market was introduced by Commodities
Exchange Nepal Ltd (COMEN). COMEN have been providing trade
services in agriculture goods. It will build warehouses to improve
services. It also applied to Securities Board of Nepal (SEBON) on
November 11, 2009 for starting a new stock exchange. Now with
new vision and new technology Mercantile Exchange Nepal Ltd.
Editorial Board: Mr. Aashik Koirala / Mr. Lakshman Pandit / Mrs. Liberty Shakya
Mercantile Exchange Nepal Limited, House No.:25, Shesh Marg, Charkhal, Dillibazar, Kathmandu, Nepal
Phone: +977-1-4423566/77/88 | Fax: +977-1-4417854/55 | E-mail: editor@mexnepal.com
MARKET PERSPECTIVE
discussions about peak oil, consumers’ fuel budgets and choices of which
vehicles or heating appliances to buy are largely affected. Oil production
capacity is limited but demand is constantly increasing, creating increased
cost of production for most producers. In a well-functioning market with
perfect competition, prices are set equal to marginal cost of production.
The large difference in this case is partly caused by the capital intense
nature of production, which makes the supply regulation to demand very
slow. Also, the price gap can be signaling scarcity of oil reserves, caused
(MEX) has been established. MEX has also made immense contribution
in raising awareness about and catalyzing implementation of policy
reforms in the commodity sector. MEX is the first Exchange to take up
the issue of differential treatment of speculative loss. It is also the first functioning without speculators.
Exchange to enroll participation of high net-worth corporate securities
members in commodity derivatives market.
Challenges for Commodity Market In Nepal
The Nepalese Commodity Market is very young. The investors haven’t
been able to analyze the situation properly. They are not smart enough
to study the situation and take good judgments. There is no regulating
body in the Nepalese commodity market. Most of the investors find the
commodity market as some sort of gambling place where people gather
together for gambling purpose and try to make out high returns with least
investments. But it is very important that one must realize that there is
a difference between gambling and speculation and the future markets.
Participants in physical markets use futures market for price discovery
and price risk management. In fact, in the absence of futures market,
they would be compelled to speculate on prices. Futures market helps
them to avoid speculation by entering into hedge contracts. It is however
extremely unlikely for every hedger to find a hedger counterparty with
matching requirements. The hedgers intend to shift price risk, which they
can only if there are participants willing to accept the risk. Speculators
Volume: 7 • Issue: 2 • Year: 2015 A.D
by a higher demand than actual oil extraction capacity disregarded
the technological capabilities. This creates large producer surpluses,
whilst the consumer surplus which is getting smaller. Present price
formation of oil products thus generates significant profit margins
for most producers. As noted previously also, oil consumption has
a strong relation to GDP development, resulting in higher demand
when developing countries become industrialized. Substantial price
increases and stable output volumes of oil provide signals that
costumers have an inelastic demand for oil, as is also the case for
electricity. Most energy products seem to have, at least in short term,
inelastic demand. It is therefore a risk involved in being dependent
of oil products, either economically or socially.
Source: U.S Energy Administration Department
Lalbabu Shah
Gahanagriha Investment Pvt. Ltd.
are such participants who are willing to take risk of hedgers in
the expectation of making profit. Speculators provide liquidity
to the market; therefore, it is difficult to imagine a futures market
So there comes a question what is the difference between a speculator
and a gambler. Speculators are not gamblers, since they do not create
risk, but merely accept the risk, which already exists in the market.
The speculators are the persons who try to assimilate all the possible
price-sensitive information, on the basis of which they can expect to
make profit. The speculators therefore contribute in improving the
efficiency of price discovery function of the futures market.
In the Nepal’s economy, there are various factors that are having
a real negative impact on the overall performance of the Nepalese
markets. The major challenges that this market is facing can be listed
as:
• Lack of market awareness and education program regarding to
commodity market.
• Government being not very supportive for the regulation of
commodity market.
• Lack of sufficient penetration of internet in urban areas,
computer literacy with minimum number of people, non-
commercialized agro production sector, lower literacy rate and
lack of knowledge of commodity market are the challenges in
this market.
• Again, the absence of a proper act and regulation, lack of
transparency among the commodities exchanges, is signaling
that a delay in bringing them under a regulatory ambit will put
large sums of money from investors in danger.
Competition from new technologies and managing long-term
investment with the potential for extreme price volatility
All in all, the commodity market in Nepal does not have a long
history and thus seems to be still underdeveloped. Government
has prepared some concepts on the commodity market for risk
minimizing for farmers but still the investors are motivated towards
earning abnormal profits from speculation. Even though the focus
is for agricultural risk management the overall utilization of the
market is for speculation. People are utilizing the derivative market
for speculating rather than risk hedging. Existing commodities
exchanges and the people who take part in the market phenomena
should be aware to keep the future of the derivatives market bright.
The commodity market needs to focus on variety of commodities
that can manage the risks of that particular commodity. The
derivative market on the resources available locally can help develop
the derivatives market as well the infrastructures making people as
well as the country resourceful. The people should be aware of these
markets and the role it can play in their economic elevation. It can
bring the stability in the market condition of derivatives in Nepal.
It is solely the effect of role that people can play to balance the
derivatives economy. How fast and with what level of ease does the
economy overcome the imbalance is what determines the future of
the Nepalese Commodity Market.
Sunita Shrestha
Master in Business Administration
SAIM College
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