Part Introduction

8/6/2019 Part Introduction

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Global ProductsGlobal Practices

Spss

A bAnk of ExCLuSIvE knowLEdgE AndInforMAtIon on CoMModItIES ECoSyStEM

CommoditY insightsYearbook 2010

Ji Eea

A


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3/172| Cmmdity Insights Yearbk 2010

introduction

The idea behind Commodity Insights, a bankof exclusive knowledge and information oncommodities ecosystem jointly published by theMulti Commodity Exchange of India and Price-waterhouseCoopers, is to provide readers/users(economic stakeholders like traders, processors,consumers, financial institutions, policymakers,analysts, industry observers, academicians, andstudents) with rare insights into the commodities

ecosystem. This is our small second step in mak-ing this yearbook a benchmark resource spreadingknowledge and providing very useful marketinformation in one place in a novel way: present-ing useful data related to commodity markets in aneasy-to-use way and a rich repertoire of analyticalarticles to portray an all-inclusive, up-to-date andlucid exposition of a range of issues and concernsthat are of paramount importance to healthydevelopment of the entire ecosystem.

The focal point of the second edition, Com-

modity Insights Yearbook 2010, is GlobalProducts, Global Practices. Towards this goal, wehave sought to achieve keen involvement of inter-nationally acclaimed authors who all are experts aswell as prolific writers in their respective domain,especially in the areas of policymaking and ide-ation. Besides, our value-adds this year will includespecific case studies on oil hedging and metals pricerisk management, data on BRIC economies, datagiving a broad perspective global economy, etc.

The yearbook, we promise, will be truly useful to

all stakeholders as a year-long, one-stop referencematerial. A fascinating and engaging read too!

About Commodity Insights


4/17A PwC & MCX Jint Endeavur| 3

PwC refers to the network of member firms ofPricewaterhouseCoopers International Limited, eachof which is a separate and independent legal entitycommitted to working together to consistently provideclients seamless services of high standards, givingPwC a competitive edge. More than 161,000 people(over 6,000 in India) in 154 countries across the PwCnetwork share their thoughts, experience and solutionsto develop fresh perspectives and practical advice. The130-year old Indian firm PricewaterhouseCoopers Pvt.

Ltd. (www.pwc.com/India) is the oldest and largestprofessional services firm that offers a comprehensiveportfolio of Advisory and Tax & Regulatory services,each presenting a basket of finely defined deliverables.

With a global outlook and local knowledge of culture,laws and business needs, PwC through its solutions tothe challenges of globalization helps clients in Indiamake the most of the changing market scenario. InIndia, PwC has offices in nine cities Ahmedabad,Bangalore, Bhubaneshwar, Chennai, Delhi NCR,Hyderabad, Kolkata, Mumbai, and Pune.

Multi Commodity Exchange of India (MCX) is ademutualised commodity exchange with permanent

recognition from the Government of India to facilitateonline trading, clearing and settlement operations forcommodity futures markets across the country. Sinceits inception in November 2003, millions of smalland medium enterprises, corporate houses, export-ers, importers and traders have benefitted from thisnationwide electronic trading platform through itsefficient and transparent price discovery and price riskmanagement. MCX is the sixth largest commodityexchange in the world and ranks No. 1 in silver, No. 2in gold and natural gas, and No. 3 in crude oil and zinc

futures trading (by the number of contracts traded),according to FIA and data on exchanges websites.

About PwC

About MCX


5/174| Cmmdity Insights Yearbk 2010

CntentsForeword....................................................................................07

From the Editorial Desk ................................................... 08

Market Commentary:

Cmmdity Markets Pised t unlck value r the

stakehlders ...............................................................................10

Experts Views:

Cmmdity Exchanges: Rle in a Glbalising Ecnmy

- Jeffrey M. Christian .................................................................18

Lessns rm the Crisis: Future Financial Regulatin

and Glbal Imbalances - Partha Ray .................................22

Mumbai as an IFC Rle Cmmdity Exchanges

- Ashima Goyal ..........................................................................30

Inter-Relatin between Dierent Markets Lessns r

Cmmdities - Adam Gross...................................................38

Price Risk Management Instruments in Agriculture

- Panos Varangis ........................................................................ 46

Cmmdity Expsures Best Practice Treatment r

Hedge Accunting - Blaik Wilson........................................52

Carbn Markets: The Pst-Cpenhagen Scenari

- Pamposh Bhat ..........................................................................60

Every ert has been made t ensure the high quality and accuracy the cntent the Yearbk. Under n circumstances, MCX and/rPwC shall nt be liable t any user r unintended/accidental errrs. The pinins/views expressed and shared by dmain experts/authrs

in all dcumented materials are their wn and d nt necessarily refect thse the rganisatins/institutins they bear allegiance t,MCX, r PwC (the views shared by Jerey M. Christian, MD and Funder - CPM Grup, are bth his and the Grups). Users/readers maycarry ut due diligence bere using any data/inrmatin herein; neither MCX nr PwC will be respnsible r any discrepancies/disputesarising ut such use.



Weather Derivatives: A Key Tl r Mitigating the

Impact Climate Change Rajas Parchure ................... 64

Metal Price Risks A New Reality - Jeffrey Bollebakker &

Arnab Ghosh ................................................................................70

Gas Pricing in India Changing Cnturs

- Deepak Mahurkar....................................................................78

Emerging Cmmdities Managing Price Risks r

India Inc - Pankaj Chandak.....................................................86

Special Feature:

Currency Futures - A Key t Managing Exchange

Rate Risk .....................................................................................58

Market Data or Ready Reerence:

Indian Ecnmy - An verview ...........................................92

Nn-Agricultural Cmmdities .........................................132

Agricultural Cmmdities ................................................. 226

All rights reserved. N part this publicatin may be reprduced, r transmitted in any rm r by any means, electrnic, mechanical,phtcpying, recrding, scanning, r therwise, withut explicit prir permissin MCX r PwC.


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Dated 5th August, 2010

Foreword

Currently, in the wake of the global financial crisis, markets in most economies around the world are undergoing

a makeover primarily in terms of the much needed transparency and robust flow of information a rigorous

exercise towards appropriate oversight and regulations. In this context, Indian markets find themselves in a much

safer and solid ground largely on the back of the prudence demonstrated by our policymakers through their

strategy of gradual and phased policy of liberalisation and globalisation over the years.

In sync with our governments vision of enabling domestic markets to graduate to the stature of price setters

in the international marketplace and the countrys economy to emerge as a powerhouse on the global economic

canvas, domestic markets have witnessed a phenomenal growth in their new pan-economic, electronic and demu-

tualised form during the past six years.

Our governments vision and policy approach found strong support in the form of enormous catalytic efforts

undertaken by the market regulator, intermediaries, and the national online multi-commodity exchanges as they

embarked upon a slew of initiatives to augment financial literacy through frequent awareness-generation and

outreach programmes. This, along with trading of innovative commodity derivative products on these exchanges

globally-competitive, efficient platforms made this remarkably fast growth possible. As a result, the total value of

commodities traded on domestic futures exchanges has over the past six years witnessed 60-fold jump to Rs.77.65lakh crore as it stands today. In volume terms, the trade has surged at a CAGR of 97.9% in the same period.

If, as per the stated vision, our domestic markets are to catapult India to the stature of a price setter at the inter-

national level from its current position of price taker and our economy to the hallowed position in the global

economic landscape it deserves, then our markets must have both an efficient price discovery and an effective risk

management mechanism in place. Again, efficiency of price discovery and effectiveness of risk management in the

marketplace are the function of a uniform and transparent flow of appropriate information on the fundamentals

and other price-moving factors of commodities through wide participation of ecosystem-wide heterogeneous

players. This in turn calls for continuous promotion of market research and efforts aimed at dynamic collation

and secure maintenance of data and information.

In this context, the joint endeavour of the Multi Commodity Exchange of India (MCX) and PricewaterhouseCoo-

pers (PwC) aimed at promoting market research and information-building processes in the countrys commodityecosystem in the form of a commodity yearbook is an extremely laudable effort indeed.

I congratulate both MCX and PwC on the release of the second edition of the compendium, which, I am sure,

would contribute its bit towards achieving the lofty objective that we all as the stakeholders of this strongly

emerging economy aspire for.

I wish Commodity Insights 2010 a grand success.

Rajiv Agarwal

Secretary (CA)

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Standing (from left to right): Mr. Niteen Jain, Mr. Sujan Bhattacharyya, Ms. Vidya Shintre, Ms. Dhwani Mehta, Mr. Nazir Ahmed Moulvi, and Mr. Debojyoti Dey.Seated (from left to right): Dr. Kiran Karande, Ms. Carol Daver, and Dr. V. Shunmugam

from the EDIToRIAL DESK

Reaching Outto enrich the Ecosystem

In our continued commitment toenriching the commodity mar-kets ecosystem, it is our pleasureto have joined hands once again

to bring out the second edition of

Commodities Insights Yearbook.

In line with the Multi Commodity

Exchanges stated focus on global

commodities and global practices,

we have reached out to some inter-

national experts, specialists in their

respective domains, to contribute

to the first part of the yearbook

dedicated to continuous knowledge

sharing and enrichment. The resultof this knowledge delivery process

is inside for all stakeholders to

read and benefit from. The experts

contributions cover multiple dimen-

sions of commodity markets, from

risk management in commodities/

verticals to global best practices in

markets and among their hetero-

geneous stakeholders to the role

commodity exchanges can play in

making Mumbai an International

Financial Centre.

Thanks to the warm response vari-

ous ecosystem stakeholders and the

users of this yearly compendium

have extended to our endeavour

with their candid feedback, we have

taken sincere efforts to provide an

increased number of useful data

sets on commodities and improve


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V. Shunmugam

Chief Economist

Multi Commodity Exchange of India

Kumar Dasgupta

Partner

Price Waterhouse

.

A PwC & MCX Jint Endeavur| 9

the overall quality of the book

based on their feedback.

Having won several credentials

in its journey to becoming Indias

largest and the worlds sixth larg-

est commodity exchange, driven

by its strategic partnerships with

various ecosystem players, it was

time for MCX to focus on creating

a global benchmark platform with

worldwide-traded commodities,

which would follow global bench-

mark practices to provide domestic

economic stakeholders with a cost-effective platform to mitigate the

forces of international commodity

fundamentals in Indian time zone.

PwC, which services clients the

world over in their efforts towards

price risk management of globally-

traded commodities, becomes

MCXs natural partner in this joint

endeavour aimed at enlightening

market participants, academicians,

corporations, and policymakerswith prices and the fundamentals

that shape them. We firmly believe

that this effort of ours will help

all these stakeholders with appro-

like to thank Sujan Bhattacharyya,

Niteen Jain, Nazir Moulvi, Dhwani

Mehta and Debojyoti Dey, all fromMCX, and Dr. Kiran Karande from

Price Waterhouse for their relentless

efforts, day in and day out, without

which our idea would not have

taken the shape of this book. It is our

pleasure to acknowledge the work

of summer interns from SCMHRD,

Pune Ms. Arshika Mishra, Mr.

Ankit Dua and Mr. L. Deepak on

updating the data sets published in

the 2009 edition. And finally, thismessage from the editorial desk will

not be complete without thanking

Ms. Carol Daver and Ms. Vidya

Shintre who helped gather financial

support for packaging this idea of

ours in a most presentable manner.

You may share your views,

thoughts, and suggestions with

us at [email protected], or at the

email addresses provided below;

this surely will help us enrichCommodity Insights even further

in future attempts.

Hope, you find this edition worth

referring to, time and again.

priate guidance in their future

decisions ranging from personal

consumption to national economicpolicymaking.

In our bid to reach out to a wider

base of stakeholders and give them

access to the yearbook than the

limitation of a printed edition allows

us to, we have already hosted the

electronic version of the first edition

of Commodity Insights on the

exchange website, www.mcxindia.

com. It draws an average of 411 visi-

tors everyday and has attracted nearly56,680 hits since it was uploaded in

May-end. To inform those who are

new to this joint endeavour of MCX

and PwC, the first issue was released

on October 14, 2009.

We would like to thank Mr. Jignesh

Shah, Vice Chairman MCX;

Mr. Lamon Rutten, MD and CEO

MCX; Mr. Parveen Singhal, DMD

MCX; and Mr. Kumar Dasgupta,

Partner Price Waterhouse; for theircontinuous encouragement and

support without which this initia-

tive of ours would have remained

unaccomplished. We also would


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With gradual realisation and acceptance by

economic stakeholders that in order to take

necessary commercial decisions, they have to

actor in global (not just domestic) availability

and prices o commodities, there has also been

a tacit recognition o the necessity o protecting

commercial operations rom the risks posed by

high price volatility at the international level. An

Ernst and Young survey in 2008 ound that there

has been an overwhelming recognition o risks

stemming rom commodity price uctuations

and, thus, o the importance o hedging o inputs

at pre-fxed prices as a risk-mitigating strategy.

However, our markets, which are mature enough

to unlock values or the stakeholders, nowneed an enabling environment that is based on

imaginative and bold policy agenda.

Commodity Markets Poised to unlock valuefor the stakeholders

For reasons with multipleimplications, commoditieshave been in the news for much

of the period since Commodities

Insights made its appearance last

autumn. Although much water

has flown since then, commodities

with their varied economic dimen-

sions have come to visit us moreoften, at times with a greater force

than before. With globalisation of

the Indian economy, nearly all

its players from tractor-driving

farmers to jet-flying corporates

are getting exposed to the vagaries

of international fundamentals

affecting commodities that they

are concerned with. Whether

the Indian economy is truly de-

coupled from the forces drivingeconomies elsewhere in the world

or not, particularly during a crisis

scenario like the current one, our

10| Cmmdity Insights Yearbk 2010

market CoMMENTARY


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domestic commodity markets,

undeniably, are linked to theglobal fundamentals of demand,

supply, policy actions and market

expectations much more now than

ever before.

New global risks andincreasing recognitiono hedging

With gradual realisation and accep-

tance by the countrys economic

stakeholders that both global avail-ability and prices of international

commodities have to be factored

in, to take the necessary production

and other commercial decisions,

there is also a tacit recognition

of the necessity of shielding their

commercial operations from risks

posed by commodity price volatil-

ity at the international level. A

2008 survey by Ernst and Young

(E&Y) across a broad range ofIndian companies found that there

has been overwhelming recognition

of the risks arising out of commod-

ity price fluctuations and, thus,

that of the importance of hedging

of inputs at pre-fixed prices as a

risk-mitigating strategy as per the

responses of most of the surveyed

lot. Yet, protection against adverse

commodity price movements is

viewed more as a tactical measure

than as a strategic device to man-age risks.

The effect of price volatility of vari-

ous commodities on corporate bot-

tom lines was amply demonstrated

by a recent study carried out by a

prominent Indian business daily.

The study used quarterly results

of over 1,500 manufacturing firms,

which indicated that expenses on

raw material had increasingly

eaten away a higher share of the

otherwise healthy performance of

their sales.

As the table shows, raw mate-

rial expenses, which had, in fact,declined by 3.19% in December

2009, increased by 59% in March

2010 and 28 percent in June 2010

for this large sample of companies.

The expenses also consistently

accounted for more than half the

sales since March 2010. Conse-

quently, net profits of these compa-

nies have been falling consistently

over the past three quarters. And

this is despite their net sales suc-

cessfully weathering adverse worldeconomic conditions to post robust

year-on-year growth.

Perhaps the companies could do

pretty little to reduce their raw

material bill. But what they could

have definitely done is to arrest

institutional environment that

could promote risk managementculture among them.

A similar survey of 1,100 compa-

nies, after their March 2010 quarter

results were announced, was con-

ducted by another publication. The

combined net profits of these com-

panies showed a marked increase

of 28.5%, year on year. However, if

the commodity companies (merely

155 in all) were left out, the net

profits of the rest fell by morethan 9 percentage points to 19.8%!

Conversely, the quarterly profits of

these 155 commodity companies

grew by more than 103%, Y-o-Y, in

March 2010, proving the dichoto-

mous effect of commodity prices

on corporate bottom lines.

the impact of commodity price

volatility and, by extension, the

volatility in their net profits. As

the table shows, increases in netprofits gyrated wildly from 67.40%

to 11.48% during the last three

quarters. Evidently, a robust risk

management tool like commodity

futures trading to hedge against

such volatility could have enabled

them to lock in input costs at pre-

determined levels. This, sadly, was

not done to the desired extent by

these companies, a result of failure

to take risk management fromtactical to strategic levels by their

management. What also added to

their woes is lack of a policy and

For an economy trying to wither

the effects of the recent financial

crisis on its foreign trade prospects,

commodity price volatility hasbeen a double whammy for its

agriculture sector in the past one

year. Such high volatility is, again,

a result of Indian agricultural

markets responding to signals ema-

nating from international markets

in an increasingly globalised world

where rapid strides in information

and communication technology

(ICT) mean that the smallest news

of relevance in the remotest partof the world can have its profound

effect felt within domestic markets

and that there remains a structural

e y ps p bls

Heads June 10 March 10 December 09

Rs. /crore % change Rs. /crore % change Rs. /crore % changeover over over

June 09 March 09 Dec. 08

Net sales 418,814 23.07 448,346 30.09 401,200 19.18

Raw Mat. Expense 210,731 27.63 235,468 58.94 159,284 (-)3.19

Raw Mat to sales (%) 50.32 1.80 52.52 9.53 39.70 (-)9.17

Net Proft 43,419 11.48 47,649 40.92 48,218 67.40

Source: Capitaline


market CoMMENTARY


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products has scarcely been able to

match their ability and needs. Thereason, as has been elucidated in

several fora by several constituen-

cies in recent years, is the slow pace

of policy and institutional reforms

for nurturing the use of commod-

ity derivatives by the stakeholders

in India.

Healthy market growth in need o policy

initiativesMarkets facilitating the trade incommodity-based derivatives in

India are regulated under the For-

correction of prices pending for

long. The double whammy is due

to volatility adversely impacting

food prices and input costs and,

thus, the bottom lines of industries

using them as raw materials. The

state machinery often tries to

intervene in the market to cushion

both sides of the market by absorb-

ing such volatility often at the costof the exchequer.

The moot point is that risks associ-

ated with commodity price spikes

and volatility have, in recent times,

risen considerably and affected

more and more economic entities

that are being exposed to risks

associated with increasing volatil-

ity while being ever more aware of

the impact of this exposure on theireconomic pursuits. While they

seek to cover these risks through

hedging against commodity price

movements, how attractive does

the market they approach appear.

The E&Y survey found nearly all

respondents to hedge through

recourse to plain vanilla products

alone. Significantly, about 68% of

them had a hedging horizon of less

than three months, indicating that

they could not explore possibilities

of long-term hedging to protectlong-term business cash flows.

Clearly, there is a demand for

safe hedging through a variety of

hedging instruments, many more

than what the market currently

provides. While OTC forward

contracts can fulfil the demand

for customised hedging products,

they lack the kind of liquidity

and safety that exchange-traded

and exchange-cleared derivativesprovide. The market for the lat-

ter, unfortunately, seems to have

run into a wall as the supply of

A PwC & MCX Jint Endeavur| 13

67.4%To 11.5% Companiesnet profits gyrated, as

wildly as this, in the past 3quarters. Surely, a robust risk

management tool like commodityfutures could have helped

lock in input costs atpredetermined

levels.


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ward Contracts (Regulation) Act,

1952, an Act enacted in the backdrop

of wartime shortages. Evidently, amarket which has grown by nearly

40% in the past four years to become

one of the largest in the world

(implying its enormous importance

for the economy) and its products

are reckoned as an investible asset

class in the league of stocks and

fixed income instruments, needs

to function under the ambit of a

market-enabling regime than this

Act allows. The intended amend-ment to the Act is yet to see the

light of day, despite being at various

stages of review by legislators for

close to four years. As a result, not

only is market development, incom-

mensurate to the level of economic

requirement being impossible to be

taken up under the existing law but

also that integration of the com-

modity futures market with the

physical ecosystem has been left

incomplete. The reluctance of bothcapital and money market regula-

tors to let their regulated entities

enter the commodity futures market

appears to be for two broad reasons:

the lack of clear policy guidelines

and the absence of an autonomous

regulator for this market. Similarly,

denying products such as options

and intangibles, which could fulfil

the hedging demand of a very large

number of stakeholders not theleast of who are from the farming

community is tantamount to

keeping these stakeholders away

from an effective risk-mitigating

device.

That economic stakeholders are

more prone to commodity price

risks under effect of global forces

has been well recognized by now.

This has been the biggest contribu-

tor to the creation of the demandside of the commodities derivatives

market. What has been less appreci-

ated is the tremendous potential

those that promote futures trading

in commodities but also remove the

hurdles on the way towards forma-tion of a pan-India physical market

for commodities setting up a solid

platform for national commodity

derivative markets.

Today, as we stand at the cusp of

history and a generation witnesses

the transition of India from a

poverty-stricken country to one

of prosperity and economic might,

the visages of control that inhibit

this transition have to be identifiedand removed. Cynics argue against

liberalising commodity markets for

a range of imaginary fears, ranging

from stoking fires of inflation to

securing supplies of key inter-

mediaries. But as our experience

with liberalisation (together with

similar actions of the other emerg-

ing superpower, China) has clearly

demonstrated, there is much more

to gain through liberalisation ofmarkets and economy than to give

into what the phantoms of imagi-

nation would lead us to believe.

After all, the Indian economy has

proven to be robust enough to

withstand and emerge successfully

from transitions and crises; and

markets, under leadership-provid-

ing regulators, mature enough to

unlock values for the economic

stakeholders. What is needed now

is only an enabling environment,created by an imaginative and bold

policy agenda, so that these values

are reaped by all stakeholders to

their fullest extent. As American

writer Ambrose Redmoon once

famously said, Courage is not

the absence of fear, but rather the

judgment that something else is

more important than fear, only

some boldness in policymaking and

a commitment towards furtherliberalisation of economic forces

can catapult us to the next level

of growth

that a fast-growing large economy

like India holds in the world of

commodities market to get backits ancient price-setting power.

Given the size of its population and

nature and growth potential of its

economy, India is one of the larg-

est producers and/or consumers of

most commodities. With liberalised

markets both physical and futures

- and an accommodative policy

regime that promotes new products

and market participation from India

and abroad, the commodity deriva-tives market in India can set global

benchmarks not only in terms of

prices discovered in its markets

but also in terms of products and

practices. Already, despite being

under a relatively restrictive market,

the countrys largest commodity

futures exchange is the sixth largest

in the world, occupying the top

position in silver and second posi-

tion in gold and natural gas. With

an accommodative policy, Indiacan definitely be the price-maker

rather than a passive price-taker

for most commodities in the world

market, especially the ones that the

stakeholders actively trade in. Such

policies would not only include

Courage is notthe absence oear, but ratherthe judgmentthat somethingelse is moreimportantthan ear

Ambrose Redmoon


market CoMMENTARY


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Documents

Part Introduction