WHERE ARE COMMODITIES STORED
Unlike equities, indices, and currencies, the futures in commodities are physical. Normally, commodity futures are used as tools for hedging underlying risk. Hence, commodity storage becomes a big challenge. Normally, the commodity storage is done in a commodity warehouse with state-of-the-art facilities including temperature and moisture regulation. Let us understand this aspect of commodity storage and commodity warehouse better and the merits and challenges of the same.
The storage of commodities is not as simple as it appears. For example, different commodities categories like base metals, precious metals, oil, gas, and Agri commodities all have different types of storage and warehousing requirements. Let us look at some unique features of commodity storage. We will look at the advantages and risks of commodity storage and commodity warehousing separately.
Let us look at some key commodities and the unique features of storage.
- Agricultural products are normally stored in silos that can protect the crop from moisture, fungal infections, obsolescence, etc. In this case, the biggest challenge in storage is to prevent wastage. For example, the FCI in India used to face huge challenges in warehousing due to old technologies deployed.
- Energy products like crude oil have a different set of requirements. Oil is stored in tankers, carriers, pipelines, tanks with floating roofs, etc. The big challenge, in this case, is to reduce the loss by evaporation as well as protect against fire and explosions.
- In India, natural gas is another important commodity. Gas normally needs to be warehoused due to low demand months. It is stored in tankers, large cylindrical tanks, or even in pipelines or containers onshore. A common method of storing gas is in depleted gas fields. A more modern method to store natural gas is the use of aquifers, which are underground water reservoirs, but this can be an expensive proposition.
- Precious metals like gold and silver are normally stored in vaults and the insurance premium on such storage is quite high considering that it is a high-value and low-volume commodity.
- Base metals are normally stored in godowns and specialized warehouses and tend to be close to the usage centers to reduce the cost of transportation.
ADVANTAGES OF STORING COMMODITIES
What are the major advantages of storing commodities? Let us look at a few key merits of the storage of commodities.
- Proper storage minimizes losses, breakage as well as spoilage, and deterioration in quality. This is very important in the case of agricultural commodities. In the case of oil, it is essential to avoid evaporation as that can lead to substantial losses.
- Many commodities, especially agricultural commodities tend to be seasonal. However, the user industries may need these all year round. For example, people consume rice and wheat around the year but the cropping season is just for a few months. That is where the need to store comes in to ensure regular supply.
- As a continuation of the previous point, this ensures that the user industries do not have to disrupt output. Today, most auto manufacturers are shutting production down due to a global shortage of microchips. That is the kind of situation that can be avoided with the planning of inventory storage.
- One of the big challenges in storage is handling. A lot of wastage and damage to goods happens in the handling part. Modern warehouses are equipped with mechanical appliances to reduce the manual handling of goods. This is not only more efficient but also safer and more efficient from an output point of view.
- Independent warehouses or government-sponsored warehouses are a boon for smaller companies. Many of them cannot afford to lock up their capital in warehouses and prefer to rent such activities. Here, even small businesses can derive all the benefits of proper storage and handle through these facilities.
- Warehouses and storage facilities are an important part of supply chain management. They not only create thousands of jobs but have a big impact on production. India incurs a huge logistical cost because of poor warehousing infrastructure. For example, India could not approve certain Western vaccines as the cold storage requirements were of a level that India did not have at a commercially viable level. These gaps can be filled up by proper warehousing investments.
- Warehouses are a place where a lot of allied activities that can assist in the final sale of the goods can be conducted. For example, many products need to be quality checked, inspected, approved, and graded. These can be done in warehousing. Also, important activities like branding, packaging, and labeling can be done at the warehouse.
- It is normally not possible to keep moving goods around as they are bulky. In the case of sales, it is possible to affect sales by transfer of warehouse receipts by accredited warehouses.
- Finance is an important aspect of storage. How do you get loans from banks against your inventory? You can hypothecate the inventory. However, the bank will insist that such goods be stored in an accredited warehouse where they can inspect and ring-fence the commodities which are hypothecated to get the loans. This addresses the working capital challenges for many businesses.
- Finally, an important advantage of storage in an accredited warehouse is the ability to ensure the goods are stored in the warehouse. Normally, insurance requires that goods be inspected, accredited, and reviewed before giving out an insurance policy. Most banks will also insist on insurance coverage of the goods as a cover against loss before they would fund these stored goods.
RISKS OF COMMODITIES STORAGE
While there are some clear merits in warehousing and storage, there are also some risks involved.
- An important risk is that prices could move against you while the goods are stored. On top of the storage costs and the warehouse rentals, you also end up losing in terms of opportunity loss on the commodity. This is quite common in the case of most commodities including agricultural and base metals.
- There is a risk of the volumes of the product or quantity depleting if not properly stored. For example, crude oil could evaporate and natural gas could leak and reduce in volumes. These are risks of storing the goods in warehouses.
- Cost risk is a specific risk that warehousing exposes you to. For example, the cost of the final commodity could go up or the inputs into the commodity could move against you.
- Finally, there are regulatory risks. This arises because some commodities can be sensitive. This is specifically true of agricultural commodities where the regulators and the government wants to avoid hoarding and too much speculative activity.
Frequently Asked Questions Expand All
In a way yes. The commodity futures price are based on the cost of carry. The cost of carry for commodities includes interest cost, insurance, storage, demurrage and expected price appreciation. The quality and the cost of storage surely affects the futures price.