Market Transparency and the House of Mirrors
Vol. 2, Issue 01 It’s an interesting stage in the evolution of the resin markets. It’s as if the markets that once resembled a darkened, haunted castle are turning into a house of mirrors. A new transactional price level in the spot market is discovered, and it’s now heard everywhere, seen everywhere. It appears in multiple newsletters and it is openly discussed in emails and telephone calls around the globe.
The reason is, of course, is rooted in the compulsive nature of competition. With newsletter like ours, The PetroChem Wire, publishing new transaction data every day, brokers and traders have followed suit, publishing their usually opinionated reaction to the latest news. Consultancies incorporate the new information into their analysis. The more attention this information receives, the more currency it gains as its own commodity. As the reliability of the information increases, more people are encouraged to not only transact based on this information, but to report even NEWER information.
Information originates with transactions. When those executing transactions keep this information to themselves, the market operates in a type of darkness. When that same information is reported, its power is immediately apparent. And the pursuit of power can be contagious.
For example, at the PetroChem Wire, we have seen the amount of information reported to our editors increase dramatically in 2009. Typically - and this is true for most commodity markets - traders are the ones to drive this transparency, by openly reporting their transactions. While other market participants may look on in horror, such as a commodity producer, they are rendered powerless as the trader’s information dictates behavior in a market for a commodity that THEY produce. This often becomes untenable for the producer community, and they too begin reporting their transactions in an open manner. When this occurs, the next group to seek influence is the consumer community, who joins the producers and traders and begin reporting their transactions as well.
As more participants report transactions to newsletters like the PetroChem Wire, the information itself becomes more trusted. New entrants are seen in the market, more transactions occur and more transactional information is reported. The transparency growth cycle feeds itself.
Illiquid markets remain in that state when perceived transactional risk is great. The greatest risks to any market’s efficiency are counterparty performance risk (that the buyer does not pay or that seller does not fulfill supply responsibilities) and benchmark price risk. The startup of cleared ethane, ethylene and polyethylene on the New York Mercantile Exchange in 2009 was a major salve to those uncomfortable with such risks in the open cash markets.
When someone buys or sells a contract volume of ethylene or polyethylene, for example, through the NYMEX Clearport system, the buyer can expect delivery of the material at the agreed price and the seller can expect payment, with both guaranteed by the NYMEX. The ethylene and polyethylene markets also frequently trades in the open spot market on an index basis: The PetroChem Wire.
With two trusted benchmarks (the NYMEX and the PetroChem Wire), transactions are more frequent, and transaction information is more transparent than ever before. The erasure of counterparty risk and the option of managing a margins account for several commodities at once through the NYMEX Clearport system have also proven to create credit and cash-flow efficiencies for many companies.
The result of achieving these evolutionary milestones is that the quality of information generated and consumed by the market community as a whole improves. False rumors and “one-off” deals are quickly dismissed. People throughout the value chain, be they analysts, consultants, sales managers, purchasing managers, brokers or traders, know the price of ethylene, and polyethylene, and ethane. And they know when information is wrong or being portrayed incorrectly.
In other words, the community is able to ask smarter questions.
Let’s look at a hypothetical situation to illustrate how this occurs. Ethylene is trading today at 42 cents per pound for February delivery, and a resin consumer is working to settle a contract purchase based on the price of the upstream ethylene. The consumer’s contract is given to him for his supply of polyethylene based on 50-cent ethylene. The consumer knows enough to ask where that ethylene price originated, and to ask why it isn’t reflecting current transaction levels in the market.
Another situation specific to resin markets relates to the issue of quality. If resin is trading to at 62 cents and a consumer receives an offer from a broker at 55 cents, the consumer will certainly ask a lot of questions about the material’s quality, or conditions of the cargo’s delivery that could account for the discounted price.
Asking smarter questions isn’t just limited to people trading the commodities. Market observers - the consultants, analysts and journalists - also begin to ask more specific questions, and the information reflected in their reports also becomes “tighter”. Outliers are now omitted from an index’s range of pricing to drag down that index’s average, because outliers are easier to spot in a transparent market.
Markets trade on information - traders live and die by knowing something minutes or hours before others in the market. But the line of general transparency has been crossed and is incontrovertible. Market participants are no longer tolerating analyst reports that list resin prices 30 cents above where brokers are offering it. Producers and consumers are no longer pretending that newsletters are not true.
Transparency has come to these markets, and they were not ruined. No one went bankrupt because of transparency. In fact, transparency helps remove the culture of blame and impotent complaining. If a company doesn’t like the price of ethylene, they can transact in the market to influence it to “go their way” - it may sound like an unethical practice to some, but that is why anyone trades today’s market - to influence tomorrow’s market.
The so-called “playing field” has been leveled to the extent that people considered to be “outsiders” to a commodity such as ethylene are now able to trade that market with confidence. The markets are no longer perceived to be controlled by producers, consumers or traders - the market is guided by the market as a collective. The greatest compliment I have personally received since the PetroChem Wire began in 2007 was from one of our readers, frustrating that prices of a particular commodity were not going the way he had forecast. The comment was: “I don’t hate your newsletter, but I sure hate what this market is doing.”
The power of the markets should rest with the market - not with a newsletter, not with a trader’s email, not with a Powerpoint presentation from a supplier. Transparency enables markets to operate with less risk, which enables trust, which increases liquidity, which enables transparency. The ethane/ethylene/polyethylene chain had a remarkable year in terms of its evolution and progress towards greater transparency, moving out of the House of Darkness and into the House of Mirrors.
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
www.petrochemwire.com
Copyright 2010