Price Wise: A better idea for resins futures

Last week's Price Wise [On Stingy Customers & Profit Margins] reported on the death of CME's resins futures contracts. After several months, the contracts have zero trading volume and open interest, rendering them illiquid and useless for effective risk management, let alone trading. They may not completely disappear soon, but their illiquidity is a tombstone.

Resins are not the first futures contracts to flop. For similar reasons (lack of experience and incentives, fear of failure, unclear directives, no risk management policy, etc. among industry participants, and a 'build it and they will come' approach by the exchange), nearly forty electricity futures contracts are also moribund. Yet, happily for electricity buyers and sellers, electricity futures aren't required to manage medium- to long-term price risk. Electricity market participants have, in natural gas, a highly correlated alternative. Natural gas is the incremental fuel for electricity generation across the U.S. and, therefore, sets forward market prices for electricity. Natural gas futures, highly liquid and option-able, made the death of electricity futures academic for buyers and sellers who want to manage risk.

What about resins? Is there an alternative, highly correlated commodity to manage long-term resins prices? Yes. As discussed earlier in Price Wise and on my website, resins are petrochemicals and their prices are tied to crude oil. Price correlations are over 90%, which is close enough to control most resins costs, protect profit margins, and retain those 'stingy customers'. However, is 'close enough' good enough?

For experienced risk managers, close enough is good enough when it comes with high liquidity and options, such as crude oil futures do. For most neophyte risk managers (plastics processors, for sure), close enough isn't good enough. Managing crude oil positions warrants familiarity with the crude oil market and neophytes crumble at the first tough question from a curious owner or CFO. Is there another solution? My suggestion --

Spread Contracts

Replace the moribund resins futures contracts with spread contracts against crude oil. (I would also change the contract size from the awkward 47,000 pounds to 10,000.) Crude oil spread contracts exist in abundance (gasoline, heating oil, and other energy commodities) and they offer plenty of liquidity.

Resins spread contracts would be easy for the CME to create. The spread sets the relative price of the resin to crude oil and contains (implicitly) the cost of production of the resin plus a profit margin, plus or minus supply/demand factors. The spread becomes the traded and negotiated variable rather than the outright price, which is more difficult to peg in any commodity market, let alone the resins market. A spread contract may be created for any resin, not just for the high-volume resins like polypropylene. Further, a spread has a lot less potential buyer's or seller's remorse built into it than an outright, and - best of all in a stingy economy - requires a lot less capital.

What do you think? If you'd like a spread contract for your resins prices, you don't have to wait for the CME to create one. If you're a processor, ask your supplier for one. If you're a supplier, ask your customer if he'd like one. You can both benefit from the highly liquid and fair-priced market you create - and maybe even resuscitate resins futures while you're at it.

About the author: Tom Langan is a risk management and trading consultant dba WTL Trading. He provides two levels of risk management services to processors and suppliers to help control resins prices, secure and improve profit margins, and increase sales.