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February 1, 2005

6 Min Read
Anyone for futures?

Going where others have tried and failed, the LME readies its futures market launch in the midst of some of the most turbulent resin pricing ever seen.

What happens if you open a futures market and no one shows? Industry onlookers with knowledge of futures in other commodities along with traders of spot plastics speculate this could be the scenario when the London Metals Exchange (LME) begins offering polypropylene (PP) and linear-low-density polyethylene (LLDPE) contracts on May 27. Conversely, the more optimistic point out that if the market takes off and transparency arrives in resin pricing-with a global benchmark polymer price coming down from the LME as opposed to the volatility and uncertainty that currently rule the day-processors and consumers stand to be big winners.

Whatever the eventual outcome, the LME is marching forward with the launch, if only in baby steps, after finishing a series of road shows promoting the program among processors, end users, and materials suppliers.

"I think the key issue we will be looking at for contract performance is qualitative instead of quantitative," explains Neil Banks, LME director of strategy. "You need liquidity coming in from both sides, and what you do is make sure that people start off in very small clips, very small trade sizes. In a thin market, the price will move more than in a very liquid market, so starting with small-sized trades means that if [the market] does move against you, nobody gets hurt."

Melt-flow meltdown

The initial market will be contracts for barefoot or pure PP with a nominal melt-flow rate of 12 and a range of 10 to 15. One lot or contract is 24.75 metric tons, which is broken down into one shipping container loaded with 18 pallets that carry 55 25-kg bags on each pallet. For LLDPE, LME has a general-purpose blown-film and blending grade, barefoot Butene copolymer, with a nominal melt-flow rate of .8 and a range of .7 to 1.2.

LME says a PP contract was "obvious" due to market structure and consumption, and LLDPE intrigued due to a high growth rate. Further contracts will depend on the success of these programs.

Some within the industry feel the resin choices were less than obvious, especially in regard to 12 melt-flow PP in the U.S. and Europe, where machinery advances and quickening production schedules have led converters to seek out PPs with rates in the 20s and 30s to maximize processing efficiency. Questions have also been raised about packaging choice-bags-since the vast majority of polymer in the U.S. comes via rail-especially for high-volume users who are the most likely to use the LME marketplace.

"We''ve clearly recognized that in the U.S. most resin is stored and delivered in hopper cars," Banks says, "and in Europe it''s about 50/50. Those packaging formats will form part of the location premium that will be fairly transparently traded in what we call the `over-the-counter market.''"

An overwhelming majority of futures contracts expire without delivery as contract holders sell their lot on an exchange, but if a buyer can''t be found, or if the price to be had seems too low, futures markets are kept honest by participants taking actual delivery.

Herein lies a potential problem. In the LME market''s early and likely ill-liquid days, buyers could be scarce. In other futures markets, if a company took delivery on a wheat contract, for example, they could look to the spot market to unload the wheat at a modest gain/loss. This might be difficult for PP and LLDPE contracts without a steady and robust spot market, especially for a PP that some have labeled undesirable due to its melt flow, packaging, or delivery location (Houston, Rotterdam, or Singapore), leaving a processor stuck with approximately 25 tons of a PP it can''t use or sell economically, or forcing the processor to abandon trading the contract, which if done by enough traders, eventually undermine this futures market.

"As far as the outside world is concerned," Banks says, "they will be looking at how easy it is for me to take a position on the exchange, and more importantly, how easy it is for me to get out of that position when I want to." A plastics trader with 20 years of experience on the existing spot and forward markets for resin (who desired to remain anonymous) noted that the prior limitations could make the LME futures more desirable among international traders than U.S. processors.

Wait and see

Also speaking on condition of anonymity, the VP of resin purchasing at a large-volume PP converter that processes 400 million lb of the material per year says that beyond any of these questions, the final call will come from the company''s customers. "If it''s not a tool that our customers want, then it doesn''t really have any interest to us. I get different reads from customers. We have some that say they want cost certainty, whether they''re hedging sugar, natural gas, or whatever. Other customers were sort of concerned that they''d get locked into a price, and if their competitors aren''t locked in in the same way, there could be times when they''re at a disadvantage."

Being locked in does have a flipside as an advantage, which Basell CEO Volker Trautz alluded to in a statement on the marketplace. Trautz, whose company sits on the LME plastics futures committee with supplier heavyweights like Dow and BP, processors like Rexam, and financial services players like Barclays and Credit Lyonnais, issued a statement pointing toward the commoditization of some resins and the opportunity that holds.

"While the polyolefin industry''s recovery from its worst downturn ever continues to build momentum," Trautz says, "so, too, does the trend toward commoditization. The futures market could provide a credible risk mechanism within the plastics supply chain that would benefit both producers and consumers of polyolefins."

Such a risk mechanism exists for other raw materials, and considering the crossover between those that consume plastic and and hedge on things like aluminum, the LME remains hopeful.

"The end consumer, people like the car companies, are very enthusiastic about it," Banks says. "Bear in mind, some of them already trade aluminum, copper, zinc, on the LME, so they''re familiar with how we operate. They''re looking for longer-term fixed-price contracts rather than just dealing on the spot market, and therefore you start moving back upstream to the converters because, in the end, consumers are going to be looking to the converters for long-term fixed-price contracts."

Tony Deligio [email protected]

Contact information

Basell Polyolefins  

London Metals Exchange  

The Plastics Exchange  

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