The Value of Transparency
Vol. 1, Issue 01 Where does the line of propriety lie between transparency and opacity?
Certainly, the value of trade secrets and insider information are so high that they are heavily regulated. Is the price of a commodity a trade secret?
Although some act as though it should be, it is not. The definition of a commodity market is that it is a fungible product easily traded between many parties. From this definition springs the debate that resin markets are not commodities, as there are thousands of grades with precise specifications that are associated with particular brands built by companies on trade secrets. This is absolutely true.
The evolution of the unbranded resin markets, however, commoditized this tier of the manufacturing chain. By removing the brand name, resins were available for purchase from brokers and distributors that come from any supplier and are sold to any buyer. By pricing this unbranded market, transparency emerges. Whether a producer and its customers chooses to price their branded material based on the transparency found in the related unbranded resin markets is their own (proprietary) business.
But resin pricing is becoming more transparent, and that transparency is here to stay.
The rise of transparency in the upstream ethylene and propylene markets has led the way for resins. Ethylene and propylene are easily commoditized because they are essentially high-purity gases that are transported in a regional system of pipelines and are stored at hubs along this pipeline system. However, the prices of ethylene and propylene were not always truly transparent.
The reliance on “posted contract prices” for ethylene and propylene for decades precluded people outside of the transacting parties to know what the true price was when discounts and cost-based formulas were applied to the commodity. If the posted price for ethylene was 60 cents, then the world-at-large believed in this price, even if those transacting in the market knew it to be 52 cents for example. The lack of liquidity in non-contract sales gave few other alternatives to “outsiders” seeking price information about the US olefins markets.
The olefins markets have come a long way in the past five years, and in June 2009 the Chicago Mercantile Exchange is introducing its first chemical futures contract for US ethylene. The transparency exhibited as the number of spot market sales increased from 1-2 per month to at least that per day has given a new sense of knowledge; not just to those transacting the market, but to those watching it from their downstream manufacturing plants. No longer does a purchasing manager for a resins processor have to guess at the prices along the supply chain between energy and processed resin. The prices of crude oil and natural gas are ever-present. The recent introduction of cleared swaps contracts for natural gas liquids has provided easily seen pricing for ethane, propane, butane and natural gasoline.
Daily olefins pricing has become more widely known in the past two years, and the introduction of a cleared ethylene futures contract will bring pricing transparency to a new level of visibility.
The writing appears to be on the wall for resins. Soon, everyone will know the price of resins! But wait, don’t they already see the prices on the London Metals Exchange for linear low density polyethylene and for polypropylene? Yes, absolutely. However, many in the downstream markets remain skeptical of the relevance of a plastic resins futures price that is not tied to its upstream markets. Still the LME’s prices are widely known and aid in the transparency movement for those seeking clarity in the unbranded PE and PP markets. The launch of the ethylene contract by the CME and its subsequent launch of a high density polyethylene contract will undoubtedly add even more clarity to the manufacturing world.
But at what cost comes such a shift in transparency? For sellers, the shift may prove to be initially uncomfortable, as they no longer remain the primary source of pricing information for the products they sell. But in manufacturing, most sellers of one product are a buyer of another, and the chain will continue to evolve to pass along this transparency. While trading oil futures was an uncomfortable change for refiners in the 1980s, the introduction of the oil futures contracts caused the markets to explode with liquidity and the refiners benefit tremendously from being the suppliers of the underlying market to these futures contracts.
The time has not yet been realized when finished packaging markets find their transparency, but the lessons of how the most successful companies in olefins and polymer markets adapt to these new instruments will be a valuable map when downstream markets reach similar stages.
For this moment in 2009, the culmination of growing transparency has evolved to a stage where regulated entities such as the CME have become useful for markets that even five years ago said they would never engage a futures exchange. If it can happen to them, it can happen to you. It happened to oil 30 years ago.
An important component of transparency is the discrimination of information. As with these early years of the Internet Age, the proliferation of misinformation hampers transparency — but its eventual dismissal leads to a recognition of seeking useful information that is validated by the underlying markets who support them. The widespread acceptance of the energy futures contracts as a valid benchmark has not killed the oil and gas industry. It has exposed information that veers too far from these prices to be irrelevant and it eventually is dismissed.
Similarly, the validation of ethylene futures, plastic resin futures and the indices supported by the active participants in the market - those with the most “skin in the game” as the phrase goes - will be the champions of the proper amounts of transparency. The term “proper amounts” is of course a loaded, pejorative descriptor, but history has shown what markets will and will not tolerate as to where to draw the proverbial line of responsible behavior as it pertains to information disclosure.
The phrase, “I don’t hate you, I hate the market” is a common refrain from those caught on the wrong side of a trend, such as a refiner whose plant has shut down at a time when gasoline prices are rising. While not an enviable position, the refiner is able to navigate it with a degree of trust that its proprietary information won’t be revealed, i.e., its identity of a buyer. This leads to the valuable aspect of anonymity secured when trading a futures contract, or reporting to a validated index. Revealing a trading party’s identity compromises the party’s position in the market. The party cannot help what the price is, but its own behavior is protected when trading on an regulated futures exchange or reporting to an index with confidentiality policies. This is a prime example of recognizing the benefits of transparency while being mindful of protecting market participant’s ability to conduct commerce.
As a result, the most reliable information strives to remove personalities from the markets as much as possible. As the phrase goes, “The price is the price.” In retail markets, which are highly commoditized, transparency has created the efficiency of eliminating bartering, which is still very much a part of the energy and chemical market process. A shopper in a market doesn’t ask a store manager for a better price on a product - if they like the price and need the product, they buy it. Conversely, if a store is overstocked with material, they don’t negotiate with shoppers in their stores, they lower prices until demand kicks in and relieves the supply overhang.
With the evolutions of technology bringing transparency to commodity markets faster than ever before, fear should not be a factor in accepting this shift, nor should anyone expect to be able to ignore it. Embracing the change and using the increase in knowledge to become more powerful is the path to greater profits, as the smartest market participants will spend their time learning how to operate best in a transparent market rather than trying to avoid it.
For more podcasts in this Transparency series click here.
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The PetroChem Wire is a daily newsletter serving the petrochemical industry. It counts every major chemical and refining company among its subscribers, as well as many major manufacturing concerns, global conglomerates, industry consultants, equity analysts and government agencies.
Contact:
Kathy Hall, Executive Editor
+1 720 480 6288
kathy@petrochemwire.com
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Copyright 2009