Commodity Supply Chains Need Protection Against Terror Attacks

Terrorists in recent times have focussed their attention on soft targets. Site-specific vulnerabilities (such as airport) and person-specific vulnerabilities (such as political leaders) have drawn the attention of most terrorists. It is important to understand a few vulnerabilities in the commodity supply chain as well and take preemptive actions to mitigate them.

A particular concern is that of transport of food and energy products, whose vulnerability to terrorist attacks has the potential to disrupt a nation’s food supply and energy requirement. The impact of terrorism on commodity trade may vary across time and place. The threat of terrorism generally implies additional costs for transactions. An increase in transaction cost might affect the flow of commodity trade.

Certain foodstuffs and agricultural products such as grains provide greater possibilities for terrorist interference than others. Grains are generally stored in government warehouses which are protected by few security personnel. Warehouses and terminals ostensibly provide more visibility to terrorists. These locations are particularly vulnerable and security to these installations needs to be enhanced. Perhaps, it would be prudent to provide security cover through a more professional force such as CISF in India.

Also the enormousness of India’s agricultural system poses a significant challenge to protect against agro-terrorism or bioterrorism (the deliberate release of biological pathogens or other harmful agents). Observers and intelligence analysts consider the occurrence of agro-terrorism to be a “low probability - high consequence” event, largely because terrorists act against their primary targets (such as transport hubs) directly creating anxiety, fear and disruption. However, there is a growing concern that terrorists may utilise agroterrorism as other types of terrorist attacks are becoming more difficult due to increased controls.

In the energy sector, many of the tank farms of petroleum and petro-chemical products are adjacent to moderate to densely populated areas that could be impacted by a terrorist attack. Road tankers that queue near the delivery and dispatch terminals are vulnerable to attacks by even a lone terrorist. The detonation of a weapon in a sabotaged truck or firing from an elevated wooded terrain adjacent to the depot could cause fatal destructions. Though large oil depots are supposed to be well protected, the current surveillance systems are more intended to prevent vandalism and theft of goods rather than a high intensity terrorist attack. Personnel issues such as the selection of drivers represent a major security concern to all modes of transportation. To understand how food and petroleum product transporters deal with the hiring of drivers along with scrutiny is particularly important. A nationwide computerised network of the commodity transport drivers and programs to educate and train drivers could provide a quick and positive return on investment.

Cargo contamination and hijacking are two of the top concerns of carriers for several years, albeit for different root causes: accidental contamination and hijacking for theft purposes. In the wake of recent terrorist events, there has clearly been a heightened spectre of a terrorist attack on food storages and energy production sites.

A precautionary measure could be to work with the local anti-terrorist squads and local police to improve and create security policies, programs and facilities for commodity supply chains. On a more fundamental level, if poorer citizens can be assured that they have access to the resources needed to live, they are less likely to adopt combative ideologies that lead to terrorism.

Published in The Economic Times

Modern Storages Are a Must for Ensuring India’s Grain Security

Investment in storage infrastructure belonged traditionally to state agencies as investment of this type was viewed as economically unattractive and too complicated for the private sector.

In recent times, subsidies have been used as financial instruments to attract private investment into storage infrastructure by effectively de-risking the investment. It is a moot point that in spite of modern silos like the one put up at Moga, why others have not taken off.

The Centre has already announced a scheme for construction of godowns through private investors under a 7-10 year guarantee scheme.

Due to political and sometimes constitutional reasons, making outright privatisation of storage infrastructure is difficult and therefore concessions have been extremely popular.

A concession provides its holder the right to operate a service for a limited period of time (usually 20 years) at the end of which all the assets go back to the government. The concessionaire is responsible for all investments as well as other eventual targets specified in the contract in exchange for the right to the cashflow of the users’ payments. However, there is a growing disenchantment with concessions in particular.

Public investment in storage infrastructure has been declining as a proportion of both total government expenditures and GDP. Government agencies provide 61% (60 MT) of India’s total agri storage capacity which also includes a hired capacity of 23 MT. Dominant producers of food grain and related agriculture products are the major users of godowns and storage capacity. The cost of building silos to store a million tonne of food grains may be about Rs 600 crore considering that the required land is made available by state governments. State warehousing corporations under Government of India like FCI have already planned galvanised silo storage systems.

Replacing bags of jute with any other material will not solve the problem of wastage. If we are planning to store food grains in galvanised silos in bulk, we should also plan for the distribution system through bulk containers. This could be planned with the help and expertise of authorities connected with the Indian Railways.

Grain safety is as important as grain saving. Each region in India has evolved storage methods to preserve grains. In villages, we have grain gola (silos); made from wood or local material that protects the grain from moisture and rodents. In most cases, villagers use neem leaves or plantbased pest resistant methods to repel pests and fungus.

However, these silos-like structures are small and they are suitable for storing village produce for a year or two. These time-tested methods are being abandoned in recent times as they are replaced with concrete godowns, with support from central and state government under various schemes. Akin to many areas of government expenditure, government subsidy programmes are often at risk of corruption and fraud at the cost of taxpayer. The extent to which these two factors affect the subsidy policy is difficult to fully estimate because it is not commonly detected or reported to official sources. Precise figures are difficult to obtain and governments are also often unwilling to publicise occurrences of fraud and corruption out of fear of bad publicity or public concern at their lack of oversight.

 *all figures in the table are in million metric tonne

Published in The Economic Times 

It Is Prudent to Include Trade Allowance into Cargo Contract

Nowadays, the majority of claims which might be faced by transporters, shipping companies, warehousemen and stevedores concerns commodity shortages. There is much confusion and uncertainty about the trade allowances which can be enforced against cargo receivers who are claiming for shortages. There is a widespread tendency to settle these disputes out of court due to the absence of clear and unambiguous rules and practices in this regard. Close observations have revealed a correlation between shortage claim, trading position and price cycle. Cargos in bulk are by nature subject to loss in weight resulting from natural shrinkage and moisture evaporation. This loss is more for some cargoes by the inevitable dispersal of cargo during the load, storage and discharge operations. Very often, local correspondents (or the surveyors) suggest some criteria to identify the trade allowances to be applied for a certain shortage without any practical acknowledgement and are easily rejected by claimants. Thus claims become a negotiation and an arm-twisting tactic.

The bulk oil shipping industry has historically accepted a 0.5% trade allowance applied to in-transit “losses” of bulk oil cargoes carried out through ocean transport. Pursuant to this allowance, unexplained shortages of less than 0.5% have been excused and unexplained losses of more than 0.5% have led to claims only for the quantity by which the loss exceeded 0.5% of the volume loaded. The economic impact of the trade allowance is considerable. This is even more complicated by the fact that not all chambers of commerce or commodity trade bodies have drawn up the collection of “customs and practices” and some have not even considered trade allowances for all types of goods.

In case of shipping under The Hague and Hague-Visby Rules, the carrier must state the quantity of cargo in the bill in accordance to the information provided in writing by the shipper. The statement is prima facie evidence that the ship had received that quantity of cargo. However, there is a proviso that the carrier is not bound to state the quantity of cargo where he has grounds for suspecting that the shipper’s figure is not accurate or he has no way of checking it. The law in this area is complex and the consequences are serious. The concept of customary trade allowance implied in contract terms almost without question assumes an unaccounted loss of 0.5 % in bulk cargo. Today, courts and arbitral panels are slow to apply the customary trade allowance. Traders having loss-making books have made it a practice to raise a dispute with commodity service providers for any natural loss and thus minimise the losses in their individual trade books.

Fighting shortage claims may be an uphill struggle, each case will ultimately depend on case facts. The phrase ‘customary allowance’ is also misleading. The 0.5% figure originally stems from the cargo underwriter’s insurance deductible. The 0.5% allowance would be better described as ‘measurement allowance’ since measurement of bulk commodity is not an exact science and many of the shortages have arisen out of inaccurate measurements. It is always prudent to include a trading/measurement allowance into the contract.

Published in The Economic Times

Price Rise and Inventory Management

When two elephants fight, it is the grass that gets trampled

-African Proverb

The next time you find that a can of your favourite beverage to be expensive then don’t blame it to government’s mismanagement. The battle of price has gone beyond the realms of monetary and fiscal policies. It is now being fought between a financial giant Goldman Sachs and a beverage giant Coca Cola. The centre of the issue is a warehousing company Metro International Trade Services.

The price of aluminum (a key input needed for the canning) has gone up by 13% since January this year. The current price of $2500 is way above the price of $1700 in June 2009. The increase is occurring despite rising inventory. Global aluminum stockpiles on the London Metal Exchange have grown from below a million tonne in 2007 to currently more than 4.5 million tonne. Metro’s stockpile totals 25% of the aluminum on LME or about 12% of the world’s warehoused aluminum. In February 2010, Metro’s acquisition for a reported $550 million by Goldman was one of the deals where financial institutions entered the littleknown world of warehousing operations. If the current stockpile remained even over a year, Goldman Sachs would earn revenue of $230 million from Metro's warehouses.

However, space rental is hardly the reason for owning a warehouse. Direct connection to the physical markets for metals can give metal traders an enormous edge in understanding the demand and supply realities and help make profitable buy-andsell decisions. This stockpiling model of commodities is becoming more and more accepted as the newest method to influence prices and secure trading advantages. It has been seen in silver with physically-backed ETFs.

During the recession in late 2008 and 2009, Metro began stockpiling aluminum. With reduced demand, producers needed a place to put their aluminum output to maintain production. They could do this by housing the metal in warehouses and selling the warrants of the metal on the LME. Metro charges a storage fee of 42 cents a tonne each day to the LME warrant holder on aluminum sitting in its warehouses. It uses an incentive system to bring in far more aluminum than it allows leaving its warehouses, causing long delays in the delivery of the metal and, in turn, inflating prices. Once the metal is in the warehouse, the producers who are paying rent sell ownership of the metal on the LME. But the created bottleneck of delivery leaves new owners waiting for months for their product to be released.

According to LME rules, only 1,500 tonne of aluminum is required to leave the warehouses each day, but an unlimited amount can enter. 

The LME created the rules in a different era when stockpiles were much smaller. The issues weren't as glaring as they are today, and it's unfair for the LME not to change dynamically with the system. Coca-Cola alleged it takes more than seven months to access its purchases from the Metro warehouses. During this time, they pay a storage fee. This means less aluminum in the physical market when the need for aluminum is rising.

Coke is accusing Goldman of limiting the supply that is leaving its warehouses, trying instead to increase stockpiles and artificially boosting the prices that producers can charge. Taking money from small consumers through financial market manipulation of commodities is very well known. But now this time, the financial giant is messing with one of the premiere global companies.

Published in The Economic Times

Right Policy Response Crucial for Developing Spot Physical Market

There are around 30,000 spot physical markets, of which 15% function under the ambit of regulation. There is a large number of markets which are not regulated under marketing laws. The unregulated markets are in the hands of commission agents. The Indian commodity physical market is currently facing three major challenges -- production, transparency and regulatory blind spots.

In spite of overflowing government warehouses, yields have not improved substantially over the years. While the government may be declaring bumper production year after year, feeding the Indian population will be an enormous challenge in time to come. India does not grow sufficient quantites of pulses and oilseeds. The production challenge is likely to force India to be a large global importer in the next few years. We all may have to agree that we do not produce enough for our population. In terms of energy consumption, we have entered an era of high prices which is likely to cause transport cost escalation in the first mile of commodity movement (farm to market yard). The average reach of a single regulated market is 459 square km. Obviously, this cannot be covered in bullock carts. The central and state governments are in the process of creating more regulated markets so that the command area of each market does not extend beyond 80 square km.

Secondly, the most important gap in transparency in the physical market for agricultural commodities concerns information on stocks. What level of stocks do we really have in foodgrain? Official figures are unlikely to match available physical stocks and no government or any official can jeopardise the truth to come out. Very few countries in the world are capable of providing information on stocks (both government and private stock). Till a few years back, commodity traders’ interpretation of “good” and “bad” production and “high” and “low” demand used to influence prices in the local market. However, in recent times, with the growth of communication, there has been an institutionalised attempt by several trade bodies to influence the production and demand data to cause distortions in price outlook. Lack of transparency in global physical agricultural markets is also adding to price swings.

Lastly, spot physical markets continue to suffer from regulatory blind spots. Regulation does not mean controls, neither protectionism, nor does it mean administrative price-fixing. However, it is important to strengthen the oversight. Lack of credit flow to agricultural sector in India has always been cited as the biggest impediment. However, in recent times the physical market is being looked increasingly for investment opportunities by a large number of interest groups. In the absence of any commodity index funds in India, financial players are increasingly entering the physical markets by opening their own trading desks. How does one ensure prevention of “financialisation” of the physical markets? Abundant liquidity due to an expansionary monetary policy and low returns on other assets is one reason which is often given for an increased investment in physical commodities.

Price volatility in commodity markets is a function of liquidity available in the local market. When crores of rupees are put to work in small markets like agricultural spot commodities, it inevitably increases volatility and amplifies prices. When the enthusiasm of financial markets meets the reality of the relatively slow-growing real economy, an adjustment of exaggerated expectations of actors in financial markets becomes inevitable. The current spot market regulations have limitations and are not geared to regulate financial flows in large scale. In absence of regulation on financial flows in physical market, one needs to find a middle path -- one which may not lead to the law of the jungle (in the absence of regulations) or a paralysis of operations (with too many rules).

In times to come, the ability of the physical market to provide food security, access at affordable price would depend largely on the policy response to production, transparency and regulation of the spot markets.

Published in The Economic Times