Shipping lanes remain the great conduits of commerce. Like the great empires of old, today’s modern trading enterprises are built on naval strength and maritime capabilities, and 90 per cent of the world’s traded goods are transported by sea.
But although the majority of raw materials and finished goods reach their destination by sailing the seven seas, the reality of commercial shipping is much more constricted than the old cliché implies. It may well face fewer logistic challenges than transporting goods across huge land-masses, but getting cargo from one point to another is far from straightforward, and there are still plenty of constraints on where and how goods can be transported.
Oil products and minerals are the most transported commodities, and the location of these resources determines many of the shipping lanes for bulks. The importance of large manufacturing regions and consumption markets also give structure to the most common maritime routes. Then there are the physical constraints: coasts, winds, marine currents, depth, reefs, and ice all play their part in determining where ships can and can’t be sent – as of course do political boundaries. There is a reason that today’s supertankers plough the same waves as the great tea clippers of the 19th century.
However, many of the maritime routes that traverse the rest of the globe are only a few kilometers wide, and a limited number of strategic ports to serve these congested shipping lanes. Even ships on the popular trans-Atlantic and trans-Pacific routes, which have a far greater choice of routes and ports, still tend to congregate around tried and tested ‘Great Circle’ paths and the ports that serve them.
So a ship cannot simply turn up in a strategic port and expect to discharge one cargo, pick up another and sail off into the sunset. One of the most critical elements in managing the profitability of any voyage, therefore, is assessing port availability, and to include that information when calculating voyage distances, bunker fuel requirements, and the type of cargo to be carried. A ship sitting idle while waiting for a berth in one of the world’s shipping choke points will be missing its laycans, possibly destroying its cargo and definitely losing business. It is effectively throwing money overboard.
Port availability is also a critical factor in determining the level of risk of any given voyage. This is not simply the financial exposure to freight rate volatility and counterparty credit risk – although again an idle ship will have deleterious effects on both – but also the personal risk of piracy. Pirates off the Somali coast and in the Gulf of Aden have already caused shippers either to pay exorbitant war risk insurance premiums, or to re-route and add delays and extra fuel costs to the journey. UNCTAD’s 2009 Review of Maritime Transport found that, based on 2007 data, re-routing 33 per cent of cargo from the Suez Canal to the Cape of Good Hope because of piracy concerns would cost ship owners an additional $7.5 billion per annum.
So charterers, ship owners and operators need accurate, up-to-date and comprehensive information on all the ports on their routes. And not just whether there is room for them. Shipping firms need quick identification of port positions – individually, by country and by zone. They need pilot information and the restrictions on draft, length overall (LOA) and beam to make sure the port can take a given vessel. They need latitude and longitude values and the UNLOC code as well as distance and routes to other ports. Even information about GMT offset and Daylight Savings Time is essential if journeys are to be optimized and delays minimized.
PwC released a survey that examined Treasury department’s reaction to the financial crisis, covering both the initial collapse of liquidity and the economic downturn that followed. The survey contained responses from 585 Treasurers, representing 330 multinational companies, from 26 different countries, covering all industry sectors.
The area of the survey that most interested me is when Treasurers were asked where they could add the most value over the next five years. The number one response by a good margin was risk management.
There were four key risk areas identified in the survey: commodity risk, FX risk, IR risk, and counterparty risk (mainly with banks). “The crisis period was not only characterised by an unexpected constriction in the availability of liquidity, but also by unprecedented volatility in FX rates and commodity prices. These market movements have kept treasurers and the wider financial community guessing as to where indices are going next.”
As we’ve said in this blog before, commodity risk is very different than FX and IR risk because of the physical supply chain aspect. “Perhaps more than other financial risks, the hedging of commodity risks need to be coordinated with the business to incorporate the effects on the physical supply chain and ultimate supply and demand dynamics.” Right, but how do you actually achieve this coordination in the real world when buying groups for various commodities are located in multiple geographies around the world and the Treasury is at corporate headquarters? Are emails, phone calls, text messages and spreadsheets the answer? Does anyone think this is a best practice when real-time information is required in a volatile world?
The survey also covered how Treasurers are moving towards more active and aggressive hedging programs. “It appears that the previous standardised approaches are increasingly seen as not being up to dealing with the volatile markets during the crisis.” However, if an organization is going to be more aggressive in its commodity management strategy it better have a good understanding of the underlying markets, employ a team with the appropriate skills and have the software infrastructure to succeed with these new strategies. “In-depth knowledge of the market and informed judgment are required if companies are to benefit from attractive market movements without moving the business beyond its approved risk appetite. This has spurred increasing professionalism in the quantitative techniques used to manage commodity price risks.” “It seems that the need for flexibility and specific functionality in capturing commodity exposures are considered by many to be beyond the capabilities of traditional TMS and that companies consequently have to either develop their own in-house system or simply rely on Excel sheets for the management of these risks.”
A PwC comment sums up what Triple Point has been seeing in non-energy and commodity trading industries – “The evolution in commodity risk management practices does not appear to be keeping pace with the rapid escalation in price volatility and is still some way behind more established treasury activities.”
Early adopters are implementing Triple Point’s market-leading commodity management solution and gaining a competitive advantage over organizations that wait.
All I have to say is don’t wait too long…
I recently had the opportunity to sit down with Carlos Lebrija, VP of Solution Development at Triple Point, to discuss Triple Point’s unique partnership with SAP and highlights of the recent Commodity SL 7.3 release.
Q: What is Triple Point’s partnership with SAP?
Carlos: Triple Point and SAP co-developed a commodity trading, risk, and operations software platform — Commodity Management™ — which utilizes best-of-breed components from both SAP ERP and Triple Point’s Commodity SL™. Commodity SL is the only solution endorsed by SAP in the commodity trading and enterprise risk management area.
Q: How did the partnership with SAP evolve?
Carlos: Through a very rigorous due diligence process, SAP picked Triple Point to partner with form all other major competitors in the CTRM space. That speaks volumes not only to our solution, but also to the people in our organization that helped influence that decision. Over the years, our work together has only gotten tighter, the result of which is Release 7.3.
Q: Describe the early days on the project…
Carlos: In the early days of 2005, it was just a handful of people from Triple Point and SAP working via multi-hour, multi-screen, multi-whiteboard conference calls. Today, there are over 70 people across both organizations working to service and bring innovation to Commodity SL customers and prospects every day.
Q: What makes Commodity SL 7.3 so significant?
Carlos: The 7.3 release provides full front-to-back integration — incluging master data, physical trades, logistics and settlement — for the first time. Commodity SL is now on equal footing with the Commodity XL platform.
Q: What are the high points of Release 7.3?
Carlos: As we laid the foundation of Commodity SL, we learned more and more about SAP and how it worked. This enabled us to develop tight integration with SAP methodology, dramatically reducing integration risk. In 7.3, the integrated solution now fully supports the most crucial elements of a complete physical trading scenario, including provisional pricing; secondary costs; a logistics model that matches SAP’s document structure; user-friendly message monitoring; and an incredibly robust technical infrastructure with automated log reprocessing, to name just a few.
Q: Now that Commodity SL is a full-blown solution, what’s next for Industry Solutions?
Carlos: We always have a few tricks up our sleeve…
CommodityPoint, an independent analyst firm, issued a research report studying the integration risk between CTRM and ERP systems. The paper does a good job of capturing the issue:
“The point is simply that just from a cost and effort point of view, any interface or point of integration including between the CTRM software and accounting software or an ERP solution is risky, costly and time consuming and this ignores other aspects of integration risk such as the inability to deploy proper workflow and controls across the application suite; the need for manual reconciliations, maintaining the same data (e.g. contract data) in multiple locations without a proper system of record and many additional limitations.”
In addition to analyzing the issue, the research discusses Commodity SL, Triple Point and SAP’s co-developed solution that eliminates the integration risk. The research hits the nail on the head as far as the value of the joint solution:
“Triple Point and SAP have developed and offer a seamless solution for commodity management which offers significant benefits for its users over and above the traditional approach of procuring a commercial CTRM solution and then interfacing it to SAP for financials. It virtually eliminates the integration risks and issues discussed above while providing significant benefits for the business. End users are offered a completely integrated suite of business systems where the complexities of ‘gluing’ the applications together is the responsibility of the vendor and where, should any issues arise, there is a single point of contact to get those issues rectified.
As the only SAP endorsed product with over 150,000 hours of co-development time invested, Commodity SL offers SAP users a best-in-class solution to their commodity management requirements that remains unique in the market today and provides significant value to those already heavily invested in SAP.”
The United Nations Conference on Trade and Development (UNCTAD) estimates that the shipping industry transported over 7.7 thousand million tons of cargo, equivalent to a total volume of world trade by sea of over 32 thousand billion ton-miles. However, managing complex cargo movements of crude and bulk commodities — across pipelines, storage facilities and vessels — remains a very manual and often disjointed process.
I recently had the chance to sit down and talk with Patrick Rooney, President and CEO of Navarik, to discuss how a cargo inspection solution can help reduce operational risk and increase straight-through processing.
Q: What are the typical cargo inspection solutions that companies use today?
Patrick: Because the majority of inspection data flows between external inspection firms and trading organizations (oil companies, trading firms, investment banks) most data associated with physical cargo transfer is gathered manually by spreadsheets, disparate systems, e-mail…even voice mail. These manual processes make it difficult to standardize and automate the cargo inspection process, resulting in great operation risk and cost.
Q: What are the issues/risk of using these manual processes?
Patrick: The trading of bulk commodities has accelerated in recent years. There is a need to standardize terminology and exchange of data between systems to facilitate straight-through processing and accelerate the settlement of trades. In a world where liquidity is being squeezed from the system; it has become increasing important to fully leverage the capital resources you have in play. To the extent that you can shorten settlement time, you essentially need less capital.
Q: How does implementing a cargo inspection solution drive efficiencies and mitigate operational risk?
Patrick: By standardizing and automating the process of cargo data inspection, you dramatically reduce the manual effort required to process inspection data. Another key driver is timely business intelligence. It allows Cargo Assurance to recover more losses from counterparties and helps operations, schedulers, and traders make more profitable decisions when selecting vessels, terminals, and suppliers.
Q: Navarik has seen rapid growth over the last two years. What are the driving forces?
Patrick: By targeting the largest international oil companies, we’ve been able to gain BP, Chevron, and Shell, as well as a major OPEC member, Venezuela, as customers. Our reach extends to over 4,000 users worldwide, including major inspection firms. Billions of barrels of oil are transported by sea every year. The value of the cargo and inherent operational risks and market volatility means companies are looking for ways to improve physical operations, reduce risk, and protect profit margins.
Q: What is Navarik’s focus going forward?
Patrick: We believe the broader oil market will follow the lead of majors in moving to our commodities inspection platform. Additionally, the entire bulk commodity shipping industry offers an attractive opportunity for our partnership with Triple Point. Together we’ll be able to offer a proven cargo inspection solution to not only existing oil customer, but customers in dry bulk commodities as well, including metals, potash, grain, and coal.
Q: What is the value of the Triple Point/Navarik relationship?
Patrick: I believe you succeed with outstanding people as a starting point, and that’s something we’ve seen at Triple Point. So when we look at our teams working together to offer the marketplace a truly integrated platform for straight-through processing — from deal execution, to physical operations, to deal settlement — I think that’s pretty special and something no one else is offering.
Interested in learning more about joint offering from Triple Point and Navarik? Read Triple Point’s Commodity XL for Inspections Powered by Navarik brochure.
TheStreet took a look at the effect of rising commodity prices on ten food companies. The companies reviewed were Hershey, Kraft Foods, McDonald’s, Starbucks, Kellogg, Sara Lee, Panera Bread, J.M. Smucker, PepsiCo, Chipotle Mexican Grill (read the article).
I have 3 take-aways from the article:
1. This is a long-term issue
“Food inflation – from corn and cocoa to sugar and wheat – is an increasingly important global issue and unlikely to go away anytime soon.”“The growing middle class in China and India where demand for beef and vegetable-based proteins grew disproportionately to demand for grain-based diets. Converting soft commodities like corn and wheat into protein — think cows and poultry — is inefficient, costly and time-consuming. ”
I’ll add that it’s not just a growing middle class issue but also one of absolute growth in population. The world added roughly 211,000 mouths to feed yesterday and will continue to do so every day for the foreseeable future. And lastly, biofuels could become an important element of the equation. Sugar is used for ethanol, palm oil is used for biodiesel and the U.S. uses roughly 25% of its corn for ethanol. There is a brewing food vs. fuel debate on the horizon.
2. Commodity costs will put tremendous pressure on margins in 2011
It’s a common theme echoed across food and beverage companies that rising commodity prices are affecting bottom lines and not all costs can be passed on to consumers through higher prices.
“Hershey cautioned its margins would continue to be pressured since passing on all the higher ingredient costs to consumers could hurt its sales.”
“Kellogg cautioned this month its margins would remain under pressure as a still-weak economy will lead it to carry some of the higher costs since raising prices could dissuade already-choosy consumers.”
“Kraft Foods said higher input costs led its operating income margin to fall 240 basis points year-over-year.”
“Higher food costs led Sara Lee to miss fiscal-second quarter earnings expectations. It said commodity costs increased by $127 million last quarter, and by $219 in the first half of its fiscal year, partially offset by $123 million in higher prices during the first two quarters, resulting in a net unfavorable commodity cost impact of $96 million.”
“In its fiscal-second quarter earnings report in November, Smucker said escalating commodity costs will continue to present challenges. Its U.S. retail oils and baking segment saw profit decline 10% in the period as costs rose for milk, sugar, and soybean oil.”
3. Commodity costs have become a CEO/CFO Issue
“McDonald’s, Chief Financial Officer, Peter Bensen said it would raise prices where it makes sense but would carry some of the higher costs itself, rather than passing it all on to consumers, many of whom patronize McDonald’s for its everyday low-cost food offerings.”
“Kraft Foods, CEO, Irene Rosenfeld said looking ahead, we expect the operating environment to remain challenging, with significant input cost inflation and persistent consumer weakness in many markets.”
“PepsiCo, CEO Indra Nooyi, said high levels of commodity cost inflation will weigh on PepsiCo’s results this year.”
“PepsiCo, CFO Hugh F. Johnston, said he expects PepsiCo’s commodity costs to rise between 8% and 9.5% in 2011.”
“Chipotle Mexican Grill, CFO, Jack Hartung said we expect continued inflationary pressure on many of our ingredients, especially chicken, beef and avocados, during the year.”
Spot trading in Europe’s flagship emissions trading scheme (EU ETS) recently ground to a halt, following the theft of 2m Allowances from the Austrian, Czech and Greek National Registries. Valued at around €30m, this theft is the latest in the series of embarrasments for the European Union, following on from a theft of 1.6m Allowances from the Romanian Registry last year. It appears that the thieves managed to acquires the Account passwords of legitimate users and effect transfers to Accounts of their own choosing. To make matters worse, the EC was aware of an imminent hacking threat, but didn’t order a lockdown of the Registry system before the theft. The EC maintains that Registry security is a matter for individual Member States. That’s technically true, but a little like failing to tell your neighbour he’s left his front door open, and he promptly gets burgled.
There is little doubt that the missing Allowances will be recovered, as each has a unique ID number and no Allowance ever actually leaves the Registry system. The whole Registry system is now on the lookout for the missing IDs, and many have already been found, but at the time of writing, 1m Allowances were still missing from the latest heist. However, with 27 EU Registries currently operating, plus numerous others which support EU Allowance transfers, the thieves have had plenty of opportunities to cover their escape through a myriad of transfers. Point Carbon, the leading industry publication on emissions trading, have spoken to a number of Registry officials, and got quotes like :
“We’ve heard the EUAs went to (an account in) Poland, then to Estonia, then to Liechtenstein, and the latest is they have left Liechtenstein, but we have no idea where they went after that.”
This sorry episode calls in to question the security protocols governing the operation of the Registries. For those of us involved in the EU ETS since its inception, the recent spate of thefts is remarkable not because they occurred, but because they did not occur much earlier and on a bigger scale, and the EU only has itself to blame.
Add clothing retailers and manufacturers to the list, along with Consumer Packaged (CP) companies and Industrial Manufacturers, of organizations that are having operating margins squeezed by rising and volatile raw material prices.
It’s become crystal clear that the commodity bull market is negatively affecting the bottom line of all companies that produce, process, transport (energy costs) or sell a physical product. The exception, of course, are the companies that own the raw material in the ground – now their bottom lines are being affected but not in a way that would make management or investors unhappy.
The rapid rise in cotton prices is causing major disruption for clothing retailers and manufacturers. Cotton prices rose 91% in 2010 (see graph below); towards the end of last year, cotton surpassed its highest price in the 141-year history of the New York cotton exchange. It’s a familiar refrain we’ve witnessed with energy and other commodities. Supply has not grown fast enough to meet rising demand from China. “World cotton production is unlikely to catch up with consumption for at least two years,” said Sharon Johnson, senior cotton analyst with the First Capital Group.
It’s created a tough choice for clothing retailers and manufacturers of whether to “eat margin” or try to pass along cost increases to consumers. Remember we are coming off a tough couple of economic years for consumers and it’s unclear how much prices can rise before there is demand destruction.
A quick scan of the news says it all:
“Gap, Wal-Mart Clothing Costs Rise on ‘Terrifying’ Cotton Prices” – Bloomberg News, Nov 15, 2010
“H&M (3rd largest fashion retailer) Q4 Profit Drops 11 Pct Amid High Cotton Prices” – CBS News, Jan. 27, 2011
“It’s really a no-choice situation…Prices have to come up” – Wesley R. Card, president and chief executive of the Jones Group, the company behind Anne Klein, Nine West and other brands discussing cotton prices
“Levi Strauss said their prices are expected to increase by spring 2011 due to the dramatic rise in the price of cotton around the world” – CBS San Francisco, January 18, 2011
And it’s not just rising prices but volatility that needs to be managed. Textile manufacturers are reporting that cotton suppliers will no longer quote firm prices in advance for new collections. “Some manufacturers aren’t taking orders for next year because of fluctuating cotton prices,” J.C. Penney Chief Executive Officer Myron Ullman said Nov. 12.
It appears the entire value chain, growers, producers, textile manufacturers and retailers don’t have the risk management processes and tools in place to manage rising and volatile raw material prices.
There was a very interesting article in The Times about industrial manufactures raising prices due to the soaring cost of raw materials.
I’ve noted in the past about Food and Beverage companies being affected by rising and volatile commodity prices – and the news continues – McDonald’s CFO, Pete Bensen, said on a recent earnings conference call that it will raise prices this year in the face of rising commodities costs.
But I haven’t seen many articles about the effects of rising commodity costs on industrial manufacturers. The Times article presents a call-out case study of Norton Motorcycles. “A motorcycle is constructed 60% (by weight) from aluminium, 20% from steel, and the remainder from a combination of plastics, rubber, paint and other materials.”
The article also lists the cost increases for these materials in the last year:
- Rubber (tires) 73%
- Steel (frame) 29%
- Aluminium (engine casting) 8%
- Plastic (fuel tank) 7%
lan McCafferty, the CBI’s chief economist, said: “Manufacturers have come under intense pressure to pass on rising costs. They have increased prices markedly in this quarter and expect to raise them at an even faster pace over the next three months.”
The publication of the article couldn’t have been more timely; Triple Point recently published a solution brief, “Commodity Management for Automotive Manufacturers and Suppliers,” in order to help manufacturers operate in this environment.
The focus for supply chain groups over the last 15+ years has been on efficiency and speed. Manufacturing and supply chain techniques such as — Just in Time (JIT) inventory management, Total Quality Management (TQM), Six Sigma and Demand Driven Supply Network (DDSN) — were introduced to eliminate waste, reduce inventory and improve quality. These efforts have led to a striking reduction in buffer inventories to bare minimum levels. In addition, these leaner supply chains have become more global as organizations look for lower cost suppliers and new markets to sell product. On one hand, this has reduced costs and opened new markets but on the other hand it has significantly limited the ability of businesses to handle unforeseen shocks to the system such as sharp raw material price rises and volatility.
The Triple Point solution brief discusses how automotive manufacturers and suppliers (really applicable to all industrial manufacturers) are facing unprecedented fundamental changes in metals, chemicals, plastics and energy market environments. In this “new-normal,” industrial manufacturers need to recognize how the same systems that have historically been deployed by energy and commodity trading companies can help them manage raw material risk and preserve profit margins.