Futures Daily: Assist the Supply-side Reform and Make Bright Prospects in Futures Market

Updated on: May 26, 2016

Reported by Que Yanmei, Journalist from Futures Daily

At the 13th Shanghai Derivatives Market Forum in Shanghai yesterday, participants generally expressed that, under the background of the supply side structural reform, the futures market price discovery and risk management functions can help enterprises to reasonably arrange production and manage price risk, effectively increase the efficiency of market allocation of resources, and promote the transformation and upgrading of industrial entities. At the same time, the futures market will guide enterprises to actively adapt to the new economic normal, and play a catalytic role in deepening the supply side structural reform.

Most commodities sectors have excess capacity

In the past more than 10 years, China's commodity market has expanded rapidly under the drive of investment. Take non-ferrous metals industry for example, in 2001, the yield of China's 10 kinds of common non-ferrous metals was only 8.84 million tons, while last year it reached 50.9 million tons, up 476%.

There are still some commodities sectors which are expanding production capacity now. In the energy industry, for example, driven by the expected rapid growth in the domestic oil product demand, China's refining capacity has been expanding rapidly since the 10th Five-Year Plan. By the end of the 12th Five-Year Plan, the supply of all kinds of oil products exceeds demand. Although refining capacity is surplus, according to professional research institutions statistics, from 2017 to 2020, China's annual added refining capacity will be about 35 million tons.

Unmatched with the capacity expansion, in recent years, with China's economic growth decline, the growth of China's demand for bulk commodities is slowing down, resulting in serious overcapacity and grim business situation in many industries. Take the nonferrous metals industry as an example, according to statistics by China Nonferrous Metals Industry Association, in the first quarter of 2016, the scale of loss of 8538 nonferrous metal enterprises is 27%, that for the copper mining and dressing is 40%, and that of lead zinc mining and dressing is 30%.

"If non-ferrous metals prices continue to decline, the industry will further increase the loss." Wu Yuneng, Deputy General Manager of Jiangxi Copper, yesterday told the journalist of Futures Daily. At present, the main coping style of enterprises is to take the initiative to shut down high-energy consumption and high-cost production capacity, reduce the loss capacity.

Last year, the Central Committee of the Party put forward the supply side structural reform with the focus of removing productivity, removing inventory, removing leverage, reducing cost, and making up short slab. That reform starts from the perspective of improving supply quality, to expand the effective supply, improve the supply structure adaptability and flexibility to the demand structure, which makes the supply system better adapt to the demand structure changes.

According to Wu Yuneng introduction, the domestic copper smelting enterprises had made the positive response to the central appeal earlier this year, and decided to jointly reduce 350,000 tons of refined copper. "If prices continue to go down, we can't rule out further cuts." Wu Yuneng says.

In addition to the active shutdown and capacity compression, many enterprises have taken effort in reducing the costs, and enhancing quality and efficiency. In addition, many enterprises pay attention to resource layout and making up resources short board. "In the face of opportunities of the market downturn and the international non-ferrous metal mining enterprises are forced to sell more high-quality mining, Chinese enterprises should actively ‘go out’, seize the resources distribution, make up resource short board, and improve the share of resources, so as to ensure long-term stable supply of non-ferrous resources." Wu Yuneng says.

However, Wu Yuneng says, due to long period of acquisition of foreign mines, large occupation of funds, and multiple force majeure factors, domestic enterprises can use the futures market to build a virtual mine to effectively circumvent these problems.

Futures tools are indispensable for enterprises to become bigger and stronger,

In fact, in the context of structural reforms in the supply side, many entities are actively taking advantage of the futures market to overcome their difficulties in addition to saving themselves by means of cost decreasing and benefit increasing.

“Compared to the spot market, the futures market has high transparency, strong liquidity and concentration of supply and demand." Wu Yuneng says, The commonly used two pricing modes for spot trading of domestic nonferrous metals industry, in particular the copper industry, are based on futures, namely average futures prices and futures quotation prices respectively to determine the base prices for purchasing and selling relevant products. As a result, the futures market can reflect actual supplies, demands and variation trends in an accurate and comprehensive manner, which makes a good guiding function for producers and operators. At the same time, the enterprise transfers the fluctuation risk of the spot price through hedging, thus realizing the material cost, the inventory and the product price locking. In the current overall gloomy economic situation, this is critical for locking the profits of enterprises.

Wu Yuneng believes that the futures market has become the supplement of domestic business entities to achieve an effective marketing and management, enterprises can make full use of the futures market for innovation management mode and operation mode, "over the past 20 years, Jiangxi Copper adheres to futures price as a benchmark to the purchase and sale, and depends on the futures market to hedge, so our business has been very robust".

In the view of Ma Wensheng, Chairman of Xinhu Futures, under the context of the supply side structural reform, the enterprises carry out the strategic management via the futures market, for example, the research on futures price volatility trend can help them decide inventory management, raw materials pricing management, expansion or reduction of production, and some long-term development strategies.

“At the same time, the enterprises can manage the price through the futures market, combine a variety of trade pricing models, and take the initiative to adapt to changes in the market." Ma Wensheng says, for example, in the process of trade with downstream customers, many nonferrous metal enterprises can take futures prices as a benchmark, and determine the trade prices after the premiums and discounts, or make the purchase contract of the monthly average price and monthly average price based on the futures market prices.

In addition, enterprises can make use of the futures market for exposure risk management. “A lot of companies are hedging the spot market exposure through futures markets, and managing the exposure of the inside spot goods. They are doing quite well." Ma Wensheng says, especially in the industry overcapacity situation, through exposure management on the spot, enterprises can gradually maintain product value, raw material value and inventory value; even if prices continue to fall, they still can guarantee profits.

Ma Wensheng believes that enterprises can also use the futures market for scale management. In the past, many domestic business models are, under the premise of stable profit, the scale drives liquidity, which promotes the scale otherwise; but with the decline of the processing profit and trade profits in recent years, the larger enterprises are facing increasing risks.

“The diversification of the pricing model and the use of futures contracts in the long term can increase the operating scale of the spot. At the same time, enterprises can also set up virtual inventory in the futures market to adjust spot production capacity." Ma Wensheng says.

In Wu Yuneng's view, Jiangxi Copper’s every step of development is inseparable from the futures market.

It is worth mentioning that, unlike steel, nonferrous metals and other industries, some domestic crude oil related industries still lack relatively authoritative price signals and risk management mechanisms. Oil futures variety system is imperfect, so that the development of related industries cannot be docked with the global market in the real sense, and they even have to rely on policy protection.

“The structural reform of the supply side of the energy industry is an important component of the structural reform in the heavy and chemical industries, and the correct guidance of the market will be an important factor in the success of the reform. The authoritative price guidance may be the focus of mutual adaption of supply and demand; enriching and improving the risk management tool system is the key factor to promote the healthy development of petrochemical industry." Cai Dongcheng, a professor at the School of Finance and Business of Shanghai Normal University says.

According to the journalist of Futures Daily, China's crude oil futures currently is quite ready; upon pending approval by the relevant departments, the transaction will be listed in the SHFE International Energy Trading Center, so as to welcome the global investors and enterprises to participate.

"With the participation of global energy related industries enterprises and investors, China's crude oil futures market may become the key index to guide the development of related industries, and it will provide an efficient risk aversion place for related enterprises." Cai Dongcheng says at the same time, SHFE can gradually improve the oil futures products series, match up with the supply side structural reform, optimize China's refined oil product standards, and apply market-oriented means to guide enterprises to adapt to the changing market demands.

To promote business transformation, the futures markets are in action

In the context of the current domestic overcapacity in many industries, the Central Committee of the Party put forward the supply side structural reform, which, for commodity related industries, is both challenges and opportunities. “In the process of pushing forward the structural reform of the supply side, futures and other derivatives markets can help enterprises achieve stable transformation." Ma Wensheng says.

“With the innovation and development of the futures market, some enterprises have innovated the commercial mode by using the futures market besides the traditional management mode." Ma Wensheng says, for example, the innovation of commodity pricing system, enterprises in the process of using the futures market have integrated upstream and downstream industry chain, and optimized the industrial chain pricing system based on futures prices,. Another example is the financing mode innovation, enterprises can use the futures market to manage the price, and use the third party warehouse to manage the spot goods, so the banks are willing to allocate funds to support enterprises needs for warehouse financing and order financing.

“In addition to futures tools, there are other risk management tools such as swaps, over-the-counter options and medium and long-term contracts on the market. These risk management tools have promoted the great changes of the operation modes of the enterprise; some business entities began to transform to price management and risk management; some enterprises transform to commodity traders, industry fund operators or asset management operators." Ma Wensheng says.

In his view, Futures Company can also help real businesses adapt initiatively to supply side reform through innovative business.

In fact, in the course of structural reforms in the supply side, the futures company sought to find ways of serving new needs of businesses through innovation. In asset management, the futures company can set up asset management plan to raise funds specifically for the enterprise risk management, and solve the funding needs of enterprises, and some of the profit allocation problems in the cooperation hedging. At the same time, the futures company asset management business may become the carrier of the future commodity industry fund.

In the aspect of risk management, the futures company can do the right trade or commodity price range service through the OTC option to make the price management more flexible. At the same time, the futures company can also carry out the financing services for enterprises. In addition, the futures company can also cooperate with enterprises to develop the traditional commodity spot trade into a "spot trade + futures + options" risk controllable commodity trading new model.

“Through these innovative businesses, the futures company can serve entity enterprises more effectively, and promote enterprises to adapt to the supply side reform." Ma Wensheng says.