Futures Daily: “Chambroad Sample” Occurs in Bitumen Business

Updated on: October 26, 2016

Reported by: Que Yanmei, Journalist from Futures Daily

Domestic bitumen market sees profit decrease due to an over-supply market, compared with the continuous profitable status in the past few years. Particularly in May, some bitumen players suffered from loss, which is being further worsened by far.
The aggravation of loss drive more and more bitumen enterprises to turn to the futures-spots combined mode to mitigate price fluctuation risk by applying futures instrument on one hand and release stock pressure through sales on the futures market on the other hand. To some extent, the availability of the futures instrument has greatly releaseded operation pressure of bitumen enterprises.

Obviously excessive bitumen supply 
As is known to all, sound profits of bitumen greatly increased its output in 2016 when many oil refineries started to intensify bitumen production and sales.
Take Shandong Chambroad Petrochemicals Co., Ltd. (CP hereinafter for short) as an example, in 2014, its sales of bitumen amounted to 0.38 million tons, increased to 0.5 million in 2015. It annual plan in 2016 was 0.9 million, with the actual being 1.1 million.
It’s worth mentioning that, despite the large growth in sales volumes, the profits are far from satisfactory. According to Liu Minna, an analyst at Baiinfo, the profit for bitumen in Q1 2016 reached RMB 270/ton, which turned to loss since May, so worsened as to a theoretical loss of RMB 214/ton in August.
The ever aggravated loss and the slack season for bitumen sales in Q4 (Q2 and Q3 are peak seasons) have resulted in a low operating rate of domestic bitumen industry, whose annual figure remains at 40%-70%. According to Liu, obvious excess in supply indicates a sluggish consequent market trend.
As for raw material supply, OPEC reached the production reduction framework agreement at the end of September, reducing daily output crude oil to 32.5 -33 barrels while Iran, Nigeria and Libya have the reduction immunity, of which Iran planed to increase to 5 million barrels/day. Russia not only greatly increased the output to break the 11 million barrels/day record, but also set a new record of 11.2 million barrels/day in the first two weeks of October.
Furthermore, in the current market situation, the US is actively selling its future shale oil output at the price of about USD 50/barrel to gain steady cash flows and realize production recovery. In this context, the international agreement of freezing production of crude oil meets with great difficulty in execution where raw material supply for bitumen remain abundant.
It’s learned that, despite the growing demand of highway maintenance for bitumen, the newly added mileage of domestic highway in this year is about 4,500km, reduced by a half or even more than the annual figure during the “Twelfth Five-Year Plan” period and 8,000km less than last year. Apparently decreased demand of highway construction for bitumen lead to reduction of domestic bitumen demands, which occurs along with the increase of bitumen supply. According to Liu, bitumen supply from January - August is expected to grow by 2.21 million tons on the YoY basis. “Though non-highway enabled part of the consumption, resources for the highway bitumen market remain excessive which turn to social stocks that are higher than those of the same period of last year”, Liu predicted. Consequent replenishment needs are lower than last year where traders maintain the pace of on-demand purchase.
“That’s why the Q4 bitumen price is suppressed. If excessive resources cannot be consumed, the price may continue to fall, whose lowest may be still lower than that of the same period of last year”, continued by Liu. Losses from winter stocks of last year continue to demotivate traders. Such a situation of resource excess won’t change in short time and support of production cost for bitumen price cannot resist the influence of excessive supply on price.
Chambroad Petrochemical Explores a New Road of Spot-Futures Combination
Faced with the situation of excessive resources and dull sales, more and more bitumen enterprises start to explore the road of spot-futures combination, amoong which, Chambroad Petrochemicals was the first pioneer in the futures market. Liu Yong told the journalist that it was since 2014 that his company really started to take the road of spot-futures combination.
Liu revealed that Chambroad managed multiple reforms and innovations of operating modes in its evolution. Before utilizing the futures instrument, the company could only receive market changes passively, not able to control profits or losses. To change such a situation, they started to leverage bitumen futures for hedging, namely, hedging of stock or production capacity by selling bitumen futures. In addition, when there is a profit margin between the current finished product sales price and the corresponding raw material price, future goods are pre-sold to secure profits in advance.
According to him, the traditional futures operation mode helped the enterprise to optimize the operating effect to a certain extent, but remained to be improved. For example, traditional futures operating mode had relatively simple participation instruments and futures varieties that were unable to constitute a risk sharing model; From the perspective of risk bearing, single market operation had high risks that were untransferable, in particular, when any serious deviation between the two markets occurred, the enterprise would face greater risks.
Liu introduced that Chambroad Petrochemicals had actively explored into the establishment of risk model by means of the multi-strategy mode and attempted to build the new operating mode combined with spot market and futures market to get deeply involved in the futures market so that futures instrument could be better utilized to help the enterprise to resist risks. 
It’s learned that Chambroad Petrochemicals was successfully listed as the factory warehouse for delivery of SHFE in the first half of this year and “Haiyun” bitumen became the registered brand of SHFE, which better facilitates Chambroad in connecting the two markets through physical delivery and market risk controlling. “Such measures have not only boosted innovation and development of operating mode, but also released pressure on spot sales in actual operations and effectively reduced the influences on price”, Liu told the journalist.
According to him, besides tradition hedging, integration of multiple futures instruments and strategies better enables enterprises to exert the risk management effect of futures instruments on daily operation. In this light, Chambroad Petrochemicals has been actively exploring new operating modes by combining the features of original futures operation and characteristics of delivery brand and factory warehouse.
“Compared to traditional hedging, our application of hedging aims at preventing price risks more flexibly. Capacity hedging, for example, can rely on warehouse receipts in case of sound bitumen production profits and sell finished products and buy raw materials in the futures market to realize capacity hedging on the premise of ensuring profits. If finished product futures price goes up, the warehouse receipts can enter delivery, thus ensuring profits will not be affected ”, said Liu.
It’s introduced that, besides futures trading, the establishment of the factory warehouse for commodity delivery and the registered brand has also brought new opportunities for the spot business of Chambroad, Sales of “Haiyun” bitumen have also risen from about 0.5 million tons in 2015 to around 1.1 million tons this year.
“Through warehouse receipt sales, hedging, buy-back and pledge operations in the futures market, profit of each ton of bitumen is RMB 400 higher than the retail price. It’s a considerable profit compared with current bitumen price ”, Liu told the journalist.
According to him, direct warehouse receipt sales to customers can not only facilitates spot sales through hedging against futures but also realize a profit that is higher than that of spot sales.
It’s learned that Chambroad has secured a volume of 40,000 tons from warehouse sales at a price of RMB 200/ton which is higher than the spot price since its factory warehouse for delivery was approved. Meanwhile, Chambroad also pledges its warehouse receipts to SHFE to obtain the 80% funds as the deposit. Such a simple and convenient operating mode with higher deposit release effectively raises fund utilization rate and helps improve economic benefits of the enterprise.

Liu told the journalist when customers holding warehouse receipts of Chambroad Petrochemicals have gained profits in trading, no receipt hedging or delivery was required, however, the company could also buy back the warehouse receipts when there was a lack of spot channel for consumption. As the receipt buy-back price is usually lower than the mainstream price in the market, re-sales can not only result in additional profits but help customers to solve the problem of spot goods consumption. “Pickup of goods by warehouse receipts mostly concentrates on peak seasons of consumption. Receipt buy-back can effectively relieve our pressure and stabilize our production and operation”, said Liu.

Futures facilitate comprehensive development of bitumen enterprises

Explorations in recent years have returned Chambroad Petrochemicals with rich experience in futures instrument utilization. According to Liu, bitumen futures have diversified positive effects on operation and management of the enterprise, including improvement in branding, business channels, economic benefits and team capacity.

For example, appropriate utilization of futures instruments can bring considerable economic benefit for the enterprise. Hedging operations in the futures market can better mitigate price fluctuation and optimize corporate operational effect; Successful utilization of multi-strategy futures operations secures extra low-risk benefits for the enterprise.

Besides, establishment of the factory warehouse for delivery brings warehouse benefits and reduces fund costs, and new operating modes change traditional spot sales of the enterprise, which are beneficial for overall planning of the spot and futures markets and change of the fixed mindset of production, purchase and sales in the past.

“Based on the seasonal demand for bitumen, price of the end of Q4 to that of the beginning of next Q1 will continue to fall, indicates a periodic low price, in this case, customers normally secure the buy-in for Q1 and Q2 next year in advance for sales of the next year ”, said Liu.

Meanwhile, the bitumen enterprise can make some forward pre-sales. For example, at the point of both low bitumen sales prices and low raw material prices, the bitumen enterprise can ask the customers to place orders so that the enterprise can secure the raw material prices.

“Factors restricting bitumen production are raw material supply and product sales. Our annual capacity is 2.3 million tons. Restricted by the upstream raw materials and downstream sales, we expect to expand the market through the futures channel ”, said Liu.

According to him, utilization of futures instruments may reduce spot market risks and enable management and operation of the enterprise. For example, the successful application of factory warehouse for warehouse can provide channel support for spot-futures combined operation of the enterprise and help the enterprise to participate in hedging business, secure operating costs and profits for spot goods production, reduce fund occupation and effectively manage spot goods operation risks.

Meanwhile, the factory warehouse for delivery may help the enterprise to conduct stock management, reduce spot stock risk and improve stock management level. In addition, turnover of goods of the enterprise within the system can be accelerated to reduce stock pressure in case of short storage capacity.

In Liu’s opinions, participation in the bitumen futures market can improve brand recognition of the enterprise. Currently, the influence of futures on the spot market is getting larger and larger. Quality standard for futures of physical delivery has become the supreme standard for the bitumen industry.

“Registration as the delivery brand urges the bitumen enterprise to constantly improve its product requirement and safety standard, which can not only benefit sound development of the industry, but also provide substantial help for the enterprise to improve its popularity and brand influence ”, said Liu. Utilization of futures instruments has proposed higher requirements for production and management of the bitumen enterprise.

According to him, an enterprise, when participating in the futures market, shall be familiar with rules for futures transactions, strictly perform the risk control system, improve various supervision and management mechanisms such as internal control, follow market rules and mitigate market risks in a proper and effective manner.

Expect more diversified industry chain future varieties

Liu told the journalist that price fall of the international crude oil after the 2008 Financial Crisis led to risks in the market. The crude oil price presents quick declines and rises. At that time, we came to realize the necessity to utilize futures for risk aversion; however, there were no listed domestic crude oil futures so that many enterprises had to establish companies in Singapore to conduct fuel oil hedging overseas. “At that time, the enterprises were well financed and bold enough, however, they lacked the awareness of risk control so that the whole industry ‘turned pale at the mention of futures’ after suffering from enormous losses.”, said Liu.

“From 2014-2015, crude oil tumbled again from USD 110/barrel to about USD 30/barrel, when bitumen enterprises were fully aware of the necessity of risk management and more and more production enterprises started to utilize futures from last year ”, said Liu.

With the quick entry of spot enterprises, transactions of bitumen futures are expanding. Officials of SHFE revealed that the first three quarters of 2016 have seen active bitumen futures transactions, apparently enhanced liquidity and expanded transaction size. As of the end of Q3, accumulative transactions of bitumen futures amounted to 143 million round lots, indicating a YoY growth of 1,133%, and a total trading amount of RMB 2.72 trillion, a YoY growth of 779.8%, when positions were also expanded.

Opportunity for bitumen capacity hedging occurred this April when price of bitumen rose sharply and crude oil price rebounded under the influence of geopolitics. Considering the over-supply situation of the whole market, they exercised capacity hedging by selling out bitumen when its price hit a high.

“We have conducted study on ration of crude oil to bitumen. At that time, the differences of prices between the spot and futures bitumen was considerable, whose basis met our criteria for operation. So we have grasped the bitumen market this year ”, said Liu. The success of Chambroad Petrochemicals in risk management of futures motivated a group of refinery enterprises in Shandong to utilization future. “Especially in this year, many refinery enterprises in Shandong begin to set up the futures department ”, Liu told the journalist.

“Their raw materials are mainly imported. Considering that there were no crude oil futures, so they set up a company in Singapore in 2007, that was used for importing hedging”. However, he also pointed out some inconveniences of hedging abroad. For example, foreign refined oil follows market-driven price while the domestic is greatly influenced by policies. Prices in the two markets are usually unhooked. The result of full hedging is hardly achieved as losses are likely to occur in both hedging abroad and domestic spot goods.

“We are longing for the launch of futures varieties like crude oil. It will be even more beneficial for refinery enterprises if futures of crude oil, gasoline and diesel can all be launched ”, said Liu. If all futures varieties in the industry chain are listed, the enterprise may exercise full hedging and secure all prices of raw materials and finished products. In this case, what are left for oil refineries are to buy in raw materials and sell out finished product at appropriate prices.

In his views, more and more enterprises will enter the futures market to better tackle the fierce market competition as futures varieties in the industry chain keep expanding.