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Trading vegetable oils and oilseeds.

TRADING VEGETABLE OILS AND OILSEEDS

Knowing the trading practices for vegetable oils and oilseeds is essential for successfully selling these commodities on the international market. Familiarity with the marketing channels is of course an important element for traders in this business. Another key aspect is skill in using the specialized contracts that have been developed for this trade. The procedures for concluding such contracts are a particularly complex part of the selling operation. Those active in the international market for vegetable oils and oilseeds should also be informed of the arbitration rules and procedures available.

Marketing channels

Most oils and oilseeds are sold through specific marketing channels. Exporters must therefore be familiar with those used for their products.

Traders: The term "trader" is often used loosely to describe anyone associated with commercial activity in oilseeds and vegetable oils. Individual traders include farmers selling ex-farm, elevators merchandising collected oilseeds, crushing plant managers, cash merchandisers at corporate head offices, government marketing authorities, brokers, commission agents, seat holders at commodity exchanges, and members of the general public who may speculate from time to time.

Cash traders have specific quantities of a raw material or derived product of a particular grade and specification to move on to customers, or to buy from merchandisers. They are concerned with the storage, transport, processing and end-use of the goods. A cash trader ensures that the commodity is properly dried and stored in appropriate conditions. He manages the inventory and its associated traded positions and assumes responsibility for booking transport and shipping.

Hedgers are another type of trader in vegetable oil and oilseed transactions. In the physical markets, the hedger's principal concern is to offset the risk inherent in holding a physical quantity of the commodity. As a result, a hedger will seek to establish an opposite position (equal, if possible) on another market, corresponding to each cash position. This may consist of selling physical quantities of, for instance, coconut oil and meal, equal in value to the copra that the hedger has purchased, or using a standard futures contract, for example, in soybeans, to hedge a cash position, in lieu of a physical hedging transaction.

Agents and brokers: An agent operates on the basis of a commission, on behalf of a seller or a buyer who grants him exclusive sales rights in a specified territory. He trades at the price set by the seller or buyer who engaged him, which includes the agent's commission.

A broker's role is similar to that of an agent, but it differs in that a broker is not tied to an individual seller or buyer. A broker's remuneration is the "brokerage" or "commission." In trade practice, the commission is not deducted until shipment or delivery has been satisfactorily made. In this sense, although the broker takes no direct market price risk, he is exposed to the performance of the parties to the contracts. A broker may also be financially liable if an error is made in the negotiation of a contract, or if notices under the terms of the contract are not passed on.

A broker is also expected to resolve contractual difficulties. He should therefore have detailed knowledge of the commodities in which he trades, the markets and the types of contracts in use. His main asset is that he runs no "book" and is therefore able to advise from an unbiased position.

The floor broker in a commodity exchange is a particular type of broker. He operates on the exchange floor, handling transactions on behalf of clients such as cash traders. Any exchange member is permitted to go into the trading pit and trade oilseeds or oilseed products if contracts exist. The floor broker earns a commission from executing the orders to buy and sell conveyed to him from the account executive, by telephone or by messenger. If the floor broker is trading on his own account, he is referred to as a "local."

Producers of oilseeds and vegetable oils, particularly those entering a market for the first time, may find it useful to work with an agent or a broker in the major market centres (London, New York, Chicago, Kuala Lumpur, Rotterdam, Hamburg and Antwerp). An agent or a broker will survey the market for suitable outlets and will supply producers with useful market information.

Merchants and dealers: Unlike agents or brokers, merchants and dealers take title to the oilseeds or oils purchased with their own capital but usually are greatly assisted by external financial sources. The merchants and dealers that act as principals are described below.

Local dealers are usually based in the producing country and operate a wide internal network designed to purchase oilseeds from farmers for transport to local mills or to ports for export. (Marketing boards act as export dealers in some developing countries.) It is not unusual for such companies or boards to provide farmers with planting seed, guarantee a minimum price for the crop when harvested, and finance the cost of seed and fertilizers until the crop is delivered.

Import dealers purchase oilseeds when seed processors are not buying, and they sell seeds to these processors when producers are not selling. Within this category fall the major trading houses and small specialized houses. These companies may take physical positions on the market or trade only in "paper" (i.e. contracts under which no delivery actually occurs). The category also includes commission houses, which offer trading facilities in futures and options contracts.

Merchant shippers are dealers that are frequently multinational companies with their own offices in both the producing and buying countries. They usually purchase from a local dealer for delivery to a silo or store in or close to a port, and resell on a "cost, insurance and freight" (CIF) basis to any port in the world where demand exists. This involves chartering vessels; arranging for the movement of goods from storage to the vessel; ensuring that quality and weights are correct, that the vessel is suitable for each particular cargo and that stowage is made in such a manner as to avoid damage to the cargo during the voyage; and providing correctly all documentation required by the buyers.

Speculative dealers have no interest in handling goods. Instead they deal in what is called the "paper" market. Following trends on world markets, they either buy or sell according to whether they believe that the market will rise or fall. They frequently purchase or sell for shipment many months ahead. They operate on the open market, usually on a CIF or a "free on board" (FOB) basis, with the intention of covering their sales or selling their purchases before the goods arrive, thereby only handling documents.

(The above categorization is fairly general. It is quite possible to find local dealers selling on a CIF basis, merchant shippers buying from farmers, and both of them speculating on the "paper market.")

A futures commission merchant is an individual (or company) who handles a sizable portion of the futures orders executed on a trading floor and who owns a seat on the commodity exchange. He provides facilities and personnel to execute customers' orders and earns a commission on each completed order. Seats are usually owned by companies whose customers include individual speculative traders, trade hedgers and floor brokers who do not belong to the clearinghouse.

A futures commission merchant undertakes a range of activities related to futures and options trading. His clearing department checks trades and verifies positions; his margin department monitors the activity of each customer's account and ensures that accounts have sufficient funds to cover trading activity; the spot commodities department handles documents relating to the delivery of actual commodities; the research department keeps customers informed about the market situation; and the order department communicates customers' orders to the trading floor. Much of the order equipment is linked to the firm's computers, so messages can be transmitted and orders executed quickly. Order clerks and messengers assist the floor trader in executing orders.

Types of contracts

Contracts are necessitated in this trade because of the complexity of the trading operations. A considerable variety of contracts exists for oilseeds, oils and meals. For the international physical or cash trade, two main organizations - the National Institute of Oil Seed Processors (NIOP) in the United States (412 First Street, S.E. 40, Washington, D.C. 20003) and the Federation of Oils, Seeds and Fats Associations Ltd. (FOSFA International) in London (24 St. Mary Avenue, London EC3 48ER) - issue various standard contractual specifications, terms and conditions in the form of pro forma contracts.

Almost all international trade in oilseeds and oils is carried out under FOSFA or NIOP contracts, or locally adapted versions of these documents. Although trading parties can contract with each other on any terms they desire, the use of pro forma contracts, particularly those containing agreed standard and semi-standard clauses (such as those of FOSFA), facilitate the transaction. When traders use a pro forma contract, they need only refer to the nonstandard parts of the commodity, its position and price. The rest of the contract is covered by pre-existing terms that have been carefully agreed to and widely accepted by the trade.

Pro forma contracts enable trade to be undertaken on a "string" basis, i.e. the trader can accomplish the entire trade procedure under the same contractual terms. This is because the organizations negotiating contractual clauses do so in close cooperation with all sections of the trade (for example shippers, middlemen, buyers and consumers) and thus ensure that the standard clauses are in harmony with trade practice, are consistent with other contracts and fit the purpose for which they are intended.

The language used in most pro forma contracts, those of FOSFA and NIOP in particular, is English. In the case of FOSFA contracts, which are the most widely used by the trade outside North America, British law applies.

The main standard clauses under FOSFA CIF and "cost and freight" (C&F) contracts are:

* Declaration of destination. This clause states that the goods are sold for shipment to a specific port, but the buyer has the option of selecting a number of other ports, provided appropriate notice is given.

* Shipment and classification. These provisions help ensure that the seller books freight with as suitable a vessel as possible, and that the merchandise is in good condition at the start of the voyage.

* Duties and taxes. This clause establishes the seller's and the buyer's responsibilities for the payment of duties and taxes. (Generally the seller is responsible for covering duties and taxes at the port of origin, and the buyer for import duties at the port of discharge.)

* Notices. Notification of the vessel, declaration of the destination and the like must be sent without delay.

* Nonbusiness days. This clause regulates the inclusion of weekends and holidays in the delivery time limits. It also specifies that, if the delivery is to be made within a given month, that month includes weekends.

* Prohibition. The provision on this subject governs the imposition of government regulations that may interfere with a trade.

* Insolvency and bankruptcy. If either party to a contract becomes insolvent or is declared bankrupt, the other party has the option of closing out the contract, either at a price to be fixed by a settlement committee or by repurchase and resale.

* Default. This clause entitles either party to the contract, by default of the other, either to buy against that person or to settle at market price at their option.

* Domicile. According to this clause, British law prevails, irrespective of the domicile of either or both parties to the contract.

* Force majeure. If the vendor is unable to deliver on the grounds of force majeure, the buyer has the option of annulling the contract or of accepting execution as soon as the initial cause of delay is removed, provided that this delay is not greater than five months. After this period, the contract is automatically terminated.

* Arbitration. The arbitration clause states that any dispute arising out of a FOSFA contract shall be referred to arbitration either in London or elsewhere if agreed by both parties. Arbitration procedures are important (see below).

Futures contracts

International trade in commodities is extremely volatile and is subject to high risks, with unexpected and drastic fluctuations in prices being an example. In the case of oilseeds and oil-bearing fruits, the risks result from the fact that consumption centres are generally located far from sources of supply and also from the vulnerability of crops to climatic fluctuations.

Modern exchanges were developed to protect market operators against the risks that they could not cover through insurance companies, commodity agreements and other means. The volatility of commodity prices, in particular, stimulated the interest of producers, consumers and processors in using futures trading to moderate their exposure to price fluctuations. At the same time, this uncertainty attracted futures speculation, enhancing the liquidity of the leading markets.

Futures contracts in oilseeds and their products have been developed only for soybeans, soybean oil, soybean meal, canola (rapeseed), crude palm oil and, experimentally, for palm kernel oil. In quantity and value terms, soybean products are massively traded at the Chicago Board of Trade, providing at least partial hedging opportunities for those trading in other oilseeds, oils or meals.

The commodity exchange or futures market not only enables buyers and sellers of the physical commodity to insure themselves against the negative effects of price fluctuations, but also performs the function of auctioneer, that is, it provides the most efficient mechanism for determining a market price. This price can then be used as a benchmark for physical transactions by producers, dealers and consumers. In addition to price determination, the futures market provides a means for disseminating information on the price levels so determined, enforcing contract performance, and addressing solvency and credit risks.

To be successful, a futures market requires a turnover high enough to make it possible to open or close out a contract or a number of contracts at a moment's notice without distorting the price. Large-volume trading provides flexibility over time, enabling futures traders to select a particular month from among an assortment of delivery months and thus to provide a hedge against the risks involved in their physical transactions.

Establishing a cash contact

A typical trading transaction for vegetable oils or oilseeds may begin simply with an exchange of telex or fax messages, or a conversation between a buyer and a seller. Alternatively, it may concern a progression of quantities of commodities agreed upon in advance, for which a price needs to be fixed. However simple its beginnings, each transaction results in a formal legal contractual document, covering every detail of the transaction as well as most foreseeable contingencies that could affect fulfillment of the sale.

Establishing a cash contract may be one of the most difficult activities undertaken by an oilseed trader. It requires in-depth knowledge of the specific commodity traded as well as of the particular circumstances under which the contract is established.

The following major aspects of the trade are usually agreed upon before the formal contract documents are prepared:

1. Quantity contracted. The agreement may be concluded before signature of the legal documents (for instance at an annual negotiation), or it could result from a regular tender (which specifies the quantity in advance and is non-negotiable). The agreement will include a tolerance on quantity of 5% to 10%, which provides for variations in inventory and in the cargo capacity of the vessel. A definition of quantity will be included, which may be an official weight certificate issued at the loading port or the amount discharged at the unloading port. In the latter case, both the buyer and the seller should monitor weight loss in shipping as a check on irregularities, as well as the check on quality (moisture content and loss).

2. Quality of the product. The quality is usually expressed in officially agreed grades and is determined at the loading port. It is guaranteed by an official certificate of quality, issued preferably by an inspector from an independent authority. This authority could be a government body (for example, the agriculture ministry) or a commercial enterprise offering the service. In certain circumstances, specific quality factors are guaranteed by laboratory certificates (such as certificates on the oil and protein content of canola).

3. Origin and destination. Origin (for "exfarm," "ex-mill" or FOB transactions) and destination (for "delivered in store," C&F or CIF transactions) are specified in the contract. "Origin" usually means the country of origin, but could also refer to a specific mill or refinery. When the commodity is widely available within the country of origin and when its specific source is unimportant and/or quality grades are easily established, various ports of loading can be acceptable. The same can apply to destinations, although these are usually more firmly established by practice. For example, while shipments to Europe could be unloaded at either Rotterdam, Antwerp, Hull or Hamburg, unloading at any other port would be unlikely. Where a choice of several ports is given, is selected port (or ports) must be declared several days before arrival and, if possible, before shipment.

4. Price. Surprisingly, price may be the least contentious issue in arriving at an agreement, for two main reasons. First, a fair price for a specific transaction can usually be easily established through reference to a general "market price." This may be a traded price published in the specialized press, or it could be a price published by an official body, such as FOSFA. For soybeans and soybean oil and meal, crude palm oil, and canola, the futures market also offers acceptable price guidance. Second, most traders are more concerned about the margin on their overall operation than about a specific price.

To arrive at the right price for a given transaction, an oilseed trader should draw up a checklist of cost items that are of critical importance. For different types of contracts, these cost items include the following:

* CIF contracts (in U.S. dollars): Import tariff (if applicable); customs or health charges; surveyor's charges; freight per ton; insurance, as a percentage of CIF value; exchange rate allowance (if agreed upon); bunker surcharge per ton; dispatch or demurrage; and outturn adjustment (if agreed on).

* FOB contracts (in local currency): Wharfage and handling, documentation; administration; storage; agent's fees; harbour fees if applicable; and export duty or subsidy (if applicable).

* DIS port (local currency): Freight (store to wharf); insurance; fumigation (if required); bagging; drumming; bulking; labour; administration; storage and handling; bank interest; cost of production or purchase; and profit margin of the enterprise.

Making an export offer

On receipt of a telex or fax requesting an offer, an oilseed or oil merchant should carry out a market and risk analysis, considering the following:

* Direction of futures and cash prices. The trader should examine the futures market or the nearest comparable market for some indication of the direction being taken by prices of oilseeds and oils. The best price indicator for edible oils is the soybean oil contract of the Chicago Board of Trade. Cash prices at various locations should also be monitored.

* Basis price levels. The difference between futures prices (if existent) and cash prices must be monitored to asses trading opportunities and the availability of storage and transport facilities. Particular attention should be paid to basis prices at export locations, which may differ considerably from the basis prices inside the country.

* Supply and demand factors. The balance of supply and demand for the oilseed or oil to be exported, and the relationship between consumption and stocks, should provide the trader with a basis for determining whether or not the market is in short supply.

* Export trade statistics. The trader must be aware of actual purchases of oilseeds or oils already made for the month(s) for which he has been asked to offer, and of recent loading rates, to get a sense of what products are "in the pipeline."

* Macro-economic factors. The development of related commodity markets is another factor that the trader needs to monitor. In the case of soybeans, this means the numbers of hogs and poultry on feed. He should also monitor the relative strengths of the currency in which the seed or oil is sold (usually U.S. dollars) against his own currency and the currency of the buyer. Interest rates are a major element in the analysis, as they are a prime component of the basis calculation.

Once the trader has analyzed the above-mentioned factors affecting the market, he must evaluate current and future conditions, including the following aspects:

* Trade position. If the trader is long (i.e. owns) cash products for the tender period, he might consider what other sales opportunities are being offered. If the trader is short (does not own) the cash product in question, he will have to find sources of supply.

* Freight. The trader should monitor freight rates and the availability of shipping space even if he is involved in an FOB sale.

* Risk factors. Changes in government regulations, the weather, war conditions and so forth have to be taken into account to assess the risk of the sale.

Examining these market conditions is likely to be an ongoing process, with the trader keeping abreast of continously changing data. The ultimate goal of the analysis is to predict by how much and where oilseeds and their products are likely to move in the future and at what price. Judgment is critical, and the trader should combine his experience with detailed research.

Arbitration

Contractual disputes may arise in the trade of vegetable oils and oilseeds that cannot be amicably settled between the buyer and the seller. To resolve such differences speedily and fairly, the major trade associations have developed systems of arbitration and appeal, with strict rules to suit particular circumstances. These remove the necessity for entering into expensive and lengthy legal procedures. All FOSFA International contracts carry an arbitration clause.

The FOSFA International Rules of Arbitration and Appeal impose strict time limits during which claims for arbitration must be made. For example, any arbitration claim in respect of quality and/or condition of the goods must be lodged within 21 days from the date of completion of discharge of the goods or 14 days from the date of certification if the claim is to be supported by a contractual analysis.

For other claims commonly called "technical" claims, the time limit is 120 days after the expiry of the contract period of shipment, or of the completion of discharge in the case of CIF contracts.

Other time limits apply to the submission of names of arbitrators and to the time in which responses are made by the party against whom the claim is made.

Each party should appoint an arbitrator and receive his acceptance of the appointment. Arbitrators or their companies must be members of FOSFA International.

If either party to a dispute disagrees with the award, it is entitled to appeal it. The committee of appeal comprises members of FOSFA International who could be shippers, intermediates, end-users or processors.

An appeal is a complete re-hearing of the dispute in question. Evidence is not restricted to that presented at the original arbitration. The hearing is a formal procedure in which oral presentations are made and heard. The board decides on its award on the basis of a majority of five members. When the decision has been made, either party may apply to the High Court in the United Kingdom for leave to appeal against the award, but only on a point of law, not of fact.

This article is based on a new ITC handbook, Vegetable Oils and Oil Seeds: A Trader's Guide, Volume I - Trading Systems and Techniques. (The second volume of this guide, Selected Products: Supply. Proceesing and Trade, has just been issued.)

PHOTO : Left, farmers in West Africa making preparations for the processing of palm oil.

PHOTO : Left, a farm worker on a plantation in the Philippines husking coconuts.

PHOTO : Above, farmers in Benin storing sunflowers for drying prior to processing.
COPYRIGHT 1990 International Trade Centre UNCTAD/GATT
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1990 Gale, Cengage Learning. All rights reserved.

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Title Annotation:Vegetable Oils and Oilseeds
Publication:International Trade Forum
Date:Jul 1, 1990
Words:4008
Previous Article:Quality management for imports.
Next Article:Defining terms and conditions in import contracts.
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