Physical Commodities Brokering: The Basics and Potential Pitfalls

Trading in physical commodities may be defined as the exchange of physical goods ranging from grown produce, such as soy or coffee beans, through precious metals to barrels of crude oil with the recipient of such transfers providing shipping from the warehouse, depot, port, or other facility from which the goods are to be collected.

Physical markets for commodities transfers deal in either cash or spot contracts for ready delivery and payment within a defined period of time, usually 11 days, or forward contracts for delivery of goods and/or payment of agreed upon price after that period.  Forward contracts for physical commodities transfers should not be confused with futures agreements.  These party-to-party contracts are fulfilled by seller delivery of the particular commodity as agreed to between the parties.  Often, forward trades stipulate cash settlement with the counterparty paying in cash the difference between the agreed future price and the prevailing market price at the time of settlement.

Rarely are these contracts for the actual delivery of the particular commodity allowed to be settled otherwise than by issuing deliveries.  One such case, however, is when the purchaser intends to resell the commodity at some point in the future.  In this instance, only the document of ownership would be exchanged at settlement.  There would be no technical delivery, and the traded commodity would remain in the same storage location.  Other examples of settlement without actual commodity delivery may arise when unforeseen and uncontrolled circumstances prevent the buyers and sellers from receiving or taking deliveries.  In these unusual circumstances, the contracts may then be settled mutually.

While the process itself is rather simple and easily comprehended, the contracts and trades themselves are anything but.  Parties to transactions may be less than honest.  Language and cultural differences may prevent complete understanding of the terms and conditions of the agreements.  Nefarious parties or personnel or associates of one or more of the parties may engage in outright theft or attempt to divert deliveries or payments.  Parties may miss critical deadlines for payment or delivery, causing their counterparties to incur unexpected costs.  Deals may fall apart at the eleventh hour.  Reputations may be damaged or ruined.

For all of these reasons, parties to a transaction often require an honest broker to bring the parties together, assure a true meeting of the minds, and monitor every phase to minimize risk.

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