International Finance News: Futures Market Assist Entity Enterprise to Become Profitable

Updated on: May 30, 2016

Reported by Zhang Jingyi, Journalist from International Finance News

Under the background of supply-side reform, the entity enterprise is actively utilizing futures market. On one hand, the futures market can rather accurately and comprehensively reflect the real supply and demand condition and its changing trend, which has rather strong guiding function for production operator; on the other hand, enterprise passes the price fluctuating risk of spot price through hedging to realize the price fix of raw material cost, inventory and product.

Under the background of new normal state of economy and continuous promotion of supply-side reform, the entity enterprise of bulk commodity is continuously adapting to the new environment.

Wu Yuneng, Deputy General Manager of Jiangxi Copper Corporation, when was in the media interview on May 26, pointed out that, enterprise should initiatively shut down and compress capacity and pay attention to cost decreasing and benefit and quality increasing to reply to reform, among which, the derivatives market will play significant role and the enterprise can utilize the financial tool of futures and share option to enhance risk resisting capacity.

The insiders analyzes and points out that, the pricing discovery and risk management function of futures market can assist the enterprise to properly arrange production and manage price risk under the background of supply-side reform, which will effectively promote the efficiency of market resources allocation and transformation and upgrading of entity industry.

Excess production capacity of bulk commodity
The scale of national bulk commodity market is quickly expanding for more than ten years under the investment-driven economic mode, but this kind of expanding scale will not last when the economic increase slow down and the demand for bulk commodity is decreasing.

Taking the non-ferrous industry as an example, the output of the common 10 kinds of non-ferrous metals is only 8.84 million tons in 2001, while the output has reached 50.9 million tons in 2015 by 476% increase.

Wu Yuneng, Deputy General Manager of Jiangxi Copper Corporation, pointed out further that the fixed investments amount of Chinese copper smelting in 2015 is ten times of that in 2003 and the copper smelting capacity is five times of that in 2003, while the consumption growth is only three times of that in 2003, thus the growth rate of smelting is larger than that of consumption and the refined copper capacity is at the excess state.

One thing that needs to be alert about is that, a part of areas and enterprises in China still to start new copper smelting project or extend the current project, and the smelting capacity still has possibility to continue to expand.

The statistics of China Nonferrous Metals Industry Association also reflects that the enterprise management situation is unprecedented severe. The losses scale of 8538 enterprises above designated scale is 27% in the first quarter of 2016, among which, the losses scale of copper mine selection is 40% and that of lead zinc ore selection is 30%.

The excess is not only appeared in the nonferrous metals sector, the energy industry is also faced with the same situation, and the national petroleum refinery distillation capacity is rapidly expanding since the Tenth-Five Year Plan driven by the expectation of quick increase of demand for national oil products, and various petroleum products all appear the condition that supply exceeds demand up to the end of the Twelfth-Five Year Plan.

The principal of one privately-operated refinery plant introduces that, the general income of refining and chemical industry in 2015 is 12 trillion yuan and the YoY basis decrease is 6% while the industry profit is 650 billion yuan decreased by 18%. The income and profit is influenced by that growing rate of national GDP and price of bulk commodity such as crude oil is decreased. Currently, the operation rate of main refinery plant is 86% and that of local refinery plant is only 31%, but the overall petroleum refinery distillation capacity of the industry in 2016 has reached 0.72 billion tons, which faces the current situation of oversupply.

Although the petroleum refinery capacity is seriously surplus, according to the calculation of professional research institution, the national annual average petroleum refinery ability will be about 35 million tons from 2017 to 2020.

The shuffling of downstream processing industry caused by excess production capacity is underway, currently, influenced by the market sluggishness, the operation rate of small and medium sized copper enterprises is insufficient obviously, which will speed up close down of excess capacity. If the price of nonferrous metals retains low continuously, the losses scale of industry would be further enlarged, said Wu Yuneng, Deputy General Manager of Jiangxi Copper Corporation.

Derivative tool is necessary to cope with industry reform

The central government forwarded the supply-side reform last year, which needs taking decrease of capacity, inventory, lever, cost and supplement for short slab as key points to enhance the supply quality, enlarge the effective supply, boost the adaptation and flexibility of supply structure to demand structure and make the supply system to better adapt to the change of demand structure.

At present, the main measures of the enterprises are actively shutting down high energy consumption and high cost capacity and decrease the loss of capacity. Wu Yuneng introduced that, the national copper smelting enterprise actively responded to the calling upon of the central government at the beginning of the year and decided to decrease the refined copper of 350,000 tons, and if the price retains to be low, the further decrease of output will be considered, and the enterprises should focus on cost decrease and efficiency and quality increase.

In fact, the entity enterprise is actively utilizing the futures market to get rid of poverty under the background of supply-side reform.

Wu Yuneng said that, Chinese enterprises should actively “go out” to grasp the resources layout, supplement for the resources short slab and enhance the resources occupancy to guarantee the long-term and stable supply of nonferrous resources, when in face of the opportunity that nonferrous metals market is sluggish and the international mine industry is forced to sell high quality mine. But he also suggested that, in view of the long term of purchasing of foreign mines, high occupation of funds and many unconsidered situations, domestic enterprises can utilize futures market to construct virtual mine to effectively avoid these problems.

Wu Yuneng told the journalist that, compared to spot market, the futures market has higher transparency, mobility and centralized supply and demand. At present, the two common price making modes for spot trade in domestic nonferrous industry, especially the copper industry, both take futures price as standard and separately average price and futures disk price to confirm the standard price of purchase and sale. The futures market can accurately and comprehensively reflect the real supply and demand situation and its changing trend, which has rather strong guiding function for production operator. Meanwhile, enterprises pass the price fluctuation risk of spot product through hedging to realize the price locking of raw material, cost, inventory and product, which is quite significant for locking the operating profit when the overall economic situation is sluggish.

Wu Yuneng believed that, futures market has become an effective market supplement for domestic entity enterprises to realize purchase, sale and operation, and enterprises can utilize futures market to innovate operating mode and pattern.

Shang Fushan, Vice Chairman of China Nonferrous Metals Industry Association also pointed out that, futures margin system, as the financial derivative instrument, has the property of monetary lever and it is a double-edged sword. To utilize the hedging tool is an important way to enhance risk management level and one of the important measures to carry out the supply-side reform of non-ferrous industry, and accelerate the completion of “three cancellations, one decrease and one supplement”, especially highlight the importance of enterprise in market under the situation that non-ferrous industry operation encounters with the difficulty of investment profit decrease, import and export decrease.

The supply-side reform exerts force continuously and the united output reduction and limitation measures of nonferrous enterprises continuously appear since 2015. The rebound range of copper, aluminum, zinc, lead, and tin at Shanghai in this year has reached 7% to 25%. The concern of nonferrous enterprises about price fluctuation is eased because many enterprises on the industrial chain have formed the hedging operation.

Futures market has a brilliant future
Reform is not only a challenge but also an opportunity for industry related to bulk commodity. Ma Wensheng, President of Xinhu Futures, said that the derivatives market such as futures can assist the enterprise to realize smooth transformation in the process of promoting supply-side reform.

In his view, under the background of supply-side reform, enterprise can utilize the futures market to carry out strategic management, such as to use the study of tendency fluctuation of futures price to assist the enterprise to confirm the inventory management, raw material pricing management, medium and long-term development strategy such as production expansion and decrease, etc.

Ma Wensheng said that, enterprise can use futures market to conduct price management, combine various trades pricing mode and actively adapt to market changes. For example, many nonferrous enterprises would take futures price as standard in the trade with down stream customers and conduct trade pricing adding, and subtracting the premiums and discounts or utilize the futures market price to make the purchase and sale contract of weekly and monthly average price. Besides, enterprise can utilize futures market to conduct risk management exposure. Many enterprises have done well in utilizing futures market for hedging of risk exposure of spot market and conducting exposure management on interior spot goods, especially under the condition of excess production of industry, the enterprise can use the exposure management of spot goods and gradually form hedging of product, raw material and inventory, and the profit can still be guaranteed although the price is falling constantly. Enterprise can also utilize futures market for scale management. In the past, the operating mode of many domestic enterprises is to use scale to drive mobility and then use mobility to promote scale under the premise of steady profit, but in recent years, the profit of processing and trade is decreased, thus the larger scale the enterprise have the bigger risk. Ma Wensheng said that, the diversity of pricing mode and utilization of hedging of futures contract can enhance the operating scale of spot goods. Meanwhile, the enterprise can use futures market to build virtual inventory to adjust the capacity of spot goods.

Wu Yuneng also pointed out that, nonferrous metals industry can step further on application of risk management and financial derivatives tools, and nonferrous metal enterprises can utilize the risk management tool more flexibly and diversified, combining with the risk control and management ability from intra-field to outfield, from futures goods to share option and from commodity futures to financial futures.

Ma Wensheng showed that, as the innovation and development of futures market, some enterprises utilize futures market to innovate business mode besides the traditional operating mode, taking the pricing system innovation of bulk commodity as an example, the enterprise integrate the upstream and downstream industrial chain, takes the futures price as standard to optimize pricing system of industry chain in the process of utilizing futures market. Another example is that the innovation of financing mode, the enterprise utilizes futures market to manage price and use the warehouse of the third party to manage spot goods, thus the bank will be willing to provide the enterprises with fund for the demand of warehouse and waybill financing.

Ma Wensheng said that, besides futures tool, there are also risk management tools such as change over, off-site share option, mid-long-term contract, etc, which promote the huge change of operating mode of enterprise, and some entity enterprises start to transform to price control and risk management and some transform to bulk commodity dealers, industry fund operators and assets managers.

One thing which needs attention is that, futures companies can also utilize innovative business to assist entity enterprises to actively adapt to supply-side reform.

Especially on the aspect of risk management, futures companies can utilize off-site share option to provide the pricing service of rights containing trade or bulk commodity for entity enterprises, and makes the pricing management to be more flexible. Meanwhile, futures companies can also provide financing service to enterprises. Besides, futures companies can cooperate with the enterprises to make the traditional spot goods trade of bulk commodity to develop to the new mode of bulk commodity trade of “spot trade + futures + share option” whose risks can be controlled.