2021 will always be remembered as a banner year for commodities as record pricing was set in a ravenous post-pandemic world. The year was shaped by the effects of the pandemic in 2020, which caused supply disruptions, halted the wheels of demand and production, and created the need for a loose monetary policy. Benefiting from liquidity injections as countries tried to revive their economies, commodities roared back to life in a resurgent 2021, catapulting prices into a stratum not seen in years. 2022 however will bring challenges beyond pricing – as commodities lawyers, we set out five trends we believe will occupy the headlines for the commodities market.
Green Targets & Black Hands
It beggars belief that in a world dominated by green energy initiatives and net zero targets, fossil fuels of coal and oil enjoyed a stellar 2021. The demonized fossil fuels have not only survived but have thrived as an energy crisis tested the resolve of many nations who found themselves resorting to these polluting black fuels. Chronic underinvestment in coal and oil production, geo-political tensions between Australia and China and the unpredictability of OPEC, means that fossil fuels aren’t going to disappear overnight. Natural gas has proven itself to be an unreliable and costly substitute to be the predominant energy fuel, while advancements in renewables continue to be limited by ageing power grids in Asia. With black hands, many stakeholders may need to temper their expectations on the speed and scale of the green transition. “Phasing down vs phasing out” was not just a hotly contested catchphrase in COP26, they represent choices that need to be carefully considered in light of the recent energy crisis –after all, the last thing anyone wants in a few years’ time is a repeat of this winter’s scramble for coal.
The Price Hangover
Most analysts agree that the heady gains of 2021 are unlikely to be repeated in 2022 for commodities. The two, sometimes parallel universes of energy commodities will continue to occupy headlines. On conventional energy, coal and oil still have legs as supply continues to be constricted. If energy companies relook their divestment plans from fossil fuel assets, they will bring their traditional efficiency and with that capacity to the market that should eventually dampen prices. The parallel universe of green energy will see a continued demand on raw materials such as copper, lithium and nickel needed for electric vehicles and batteries. But the real question for 2022, turns on whether supply has caught up. Commodity prices are volatile because underlying demand can get ramped up with speculative liquidity bolstered by low interest rates. By that same token, a perception of oversupply and tightening monetary policies can easily bring prices back to more sobering levels. Previous commodity cycles have shown that contracts done in the exuberance of a rising market tend to end up in litigation when a price inflexion occurs.
Transparency & Liquidity
The opaque nature of international trade came to the forefront in 2020 with a series of trade fraud scandals. Commodities took the brunt of that fallout, largely because physical goods and their paper title documents, move at different speeds, and involve different actors. The physical goods can only move in a linear fashion between origin to destination but it’s the paper documentation that finds itself the subject of financial alchemy as they are traded forwards, backwards or in circles in a chain of traders. Sometimes documents don’t move at all while at other times worthless photocopies of title documents are circulated. In the oil trade, hundreds of millions of dollars of oil can be bought and sold between traders and their lenders, with neither party even being aware where the title documents are. The disjointed and opaque nature of international trade meant that fictitious or synthetic trades could be created with relative ease – typically for the purposes of creating liquidity.
The addiction to liquidity at the heart of most trade fraud schemes, cannot be eradicated overnight. But removing the conditions that allow it to flourish – the archaic use of paper documents and fragmented information flows, might be the best solution to putting an end to this problem. In that regard, Singapore has spearheaded the move with its forward-thinking initiatives in legislation for the recognition of electronic documents and the development of the SGTraDex project. SGTradeDex aims to create a secure data sharing infrastructure that would streamline fragmented information flows and hopefully eliminate double financing. The initiative is bold and complex but the secret sauce in its efficacy will be in its adoption in 2022 and beyond.
Fintechs & Chasing Scale
Although not necessarily limited to the commodities market, fintechs have exploded over the past few years particularly in the business of invoice financing. The combination of Basel regulations and the labour intensiveness of implementing an invoice or supply chain financing program have resulted in a steady exit of banks and in their place, the rise of fintechs who hold the promise of greater efficiency with the use of technology. A fintech can come in many shapes and sizes but like any business, it requires investment which in turn requires scale – platforms typically boast of the high volumes of trades and invoices funneled through it. There is nothing wrong with this evolution so long as the end result does not become the starting point. Our work continues to reveal the danger of failing to detect fictitious trades or invoices in this pursuit of scale. Even more troubling is the proposition of illegitimate invoices being deliberately channeled into a platform to raise valuations. Securitizing “invoice receivables” portfolios, sometimes with a poor understanding of credit insurance adds a further layer of complexity and pushes the actual underlying trade further away from scrutiny. There is often a lot more than meets the eye – the high-profile collapse of Greensill in 2021 is a cautionary tale against the dangers of pursuing scale at all costs.
ESG & Carbon Trading
Climate change and ESG (Environment, Sustainability and Governance) goals are increasingly gaining prominence but the lack of clarity around them continues to confuse companies and board directors alike. Reducing carbon footprint should rightfully be at the top of any corporate agenda – this will involve a holistic and honest assessment of the business and its supply chain. Reducing carbon use however is only part of the strategy to “net zero”, the other will invariably entail the purchase of carbon credits to offset emissions. This can be done in the voluntary carbon market but there are real challenges in creating a carbon trading market. Carbon, like any other commodity can be traded directly between buyer and seller or on an exchange such as Air Carbon Exchange in Singapore or Carbon Trade Exchange in London. Singapore has even recently launched a new exchange in the form of Climate Impact X. The challenge however lies on many levels starting with the lack of uniformity in how carbon credits are created and verified and as a result, skepticism against “greenwashing”. Conventional commodities are traded across the world at such volumes that recognized pricing has developed based on their physical traits, grades and even geographies. Carbon credits however can be produced from a wide range of projects with varying characteristics and different aims, creating transparency and reliability concerns over pricing. Credible pricing requires not just transparency but extensive market participation and with any new complex area that requires adoption, simplicity remains key.
* This article was first published in The Business Times on 18 Jan 2022.
