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

Don’t Ignore Ancient Wisdom in Predicting Monsoon, Drought

Monsoon prediction has long been a touchy and sticky issue in India. Monsoon has price implication on commodities as well as on the perceived health of the overall economy. Monsoon is the greatest single factor in Indian agriculture and thus myth impinges on it as well.

According to legends, Vritra (personification of drought) kept the waters of the world captive. He was killed by Indra (Lord of Heaven) by destroying all the ninety-nine fortresses of Vritra before liberating the imprisoned celestial rivers.

Humans have always wanted to predict the future. Never this has been truer than when it comes to the weather. The difficult part is in getting the forecasts correct. There are different criteria between long-range and the shortrange forecasts. The information available in a longer term is much more of the trend variety, so the temperatures will be ‘above average or below normal’ or ‘a heat wave or a cold wave’. It’s nothing specific as in the short-range. The department of meteorology uses all the internationally-approved parameters as well as cutting edge technology. The state-of-the-art Doppler S Band radar in Mumbai, costing around Rs 10 crore, does not have many expert interpreters. A nation which has spent thousands of crores of rupees on capital-intensive equipment still looks to experts like fishermen to spot the altered behaviour of fish to predict the rains.

The farmers continue to rely on the age-old almanac (panchang) to predict the local rainfall. It is not only the challenges to dissemination of forecasts (in absence of information delivery mechanism) but the ambiguous forecasts like ‘medium to heavy rainfall is expected around West Coast’ leaves a question mark on the veracity and utility for the local farming community.

The classical Indian almanac gives the calculations that enable many people to predict bi-weekly average rainfall. Though its correctness has often been denounced by the modern meteorologists, however, the high level of the usage in rural and semi-urban India cannot be undermined. In the ‘panchang’, the lunar year has been considered with every fourth year having thirteen months to adjust to the earth’s natural year. Various stars, planets and constellations in the sky are divided into 27 parts, called the nakshatras. Every nakshatra cannot be located easily like a zodiac sign because it is a part of the sky as seen only from a particular point on earth. Of the 27 nakshatras, nine are during the monsoon, and are called the monsoon nakshatras. Two important treatises by Sage Varahamihira called ‘Brihatsamhita’ and ‘Panchasiddhantika’ gives the details of how the calculations are done and the principles used in formulating predictions.

Anand Agriculture University (AAU) scientists are conducting a study to see if these movements have an impact on the occurrence of rains. The study aims to blend astrology and meteorology to predict the quantum of rainfall in a particular year -- whether it will be a good monsoon or a drought year. AAU has already distributed the questionnaires and the almanac to ‘sarpanchs’ and ‘talatis’ of the 18,000 villages across Gujarat. They have been asked to fill in details like the quantum of rainfall and how long it rained, on a daily basis in the calendar and reports it monthly to AAU. The daily rainfall data received from all villages as per the astro-meteorological calendar will be collected and compared with 100 years of rainfall data of 200 rainfall stations across Gujarat. AAU will then study and analyse as to what extent does astrological movements affect rainfall.

Over the last decade, the monsoons have become more and more erratic. In spite of using the 16 parameter model for long-term rain prediction, the forecasts are going exceedingly haywire.

Published in The Economic Times 

Commodity Markets Lack ‘Good Intentioned’ Credit Flow

Cash markets in commodities are often marked by price opacity and credit flow constraints. Market modernisation planners often argue to bring price transparency and free flowing credit into spot market -- a very noble cause with a perfect theoretical underpinning.

The lack of “good intentioned” credit flow into the commodity market has also been constrained by limited access of spot markets for the financial institutions. The market modernisation plan implementation will bring in the national common market perspective to the country.

In contrast to financial commodities markets, which are tightly scrutinised by national watchdogs, the physical markets are largely unregulated. The industry relies on common law and on private pricing agencies for price discovery. Even, The International Organisation of Securities Commissions (IOSCO) has told G-20 that physical commodity markets were beyond the jurisdiction of most regulators.

Commercial speculation in agriculture has traditionally been used by traders and processors to protect against shortterm price volatility, acting as a sort of price insurance while helping to set a benchmark price in the cash market. The non-traditional traders who are not interested in the commodities themselves have increased the interdependence between commodity and financial market in the West.

A possibility exist that if not regulated properly, by making the spot window available nationwide the localised commercial speculation will get a chance to translate into a larger financial speculation in the physical space. The increasing demand and at times sudden withdrawal by non-traditional traders is considered by many, to have influenced the demand and supply fundamentals.

If the cash market is opened on a nation-wide scale, the buyers are likely to get multiple location windows to buy. Some argue that the seller producers due to location specificity and a low withholding power tend to have naturally reduced bargaining capacity. The proponent of the electronic markets may argue on the contrary that the sellers get to sell the produce nationwide. Good logic, however, we must recognise that the severe impediments like poor digital-infrastructure, information asymmetries, limited access to affordable credit, weak institutional support and globalisation of supply chains with rising barriers for small producer constraints the producer-seller. Taken together, they all represent a low bargaining capacity. A transaction between unequal cannot be called balanced only by mere increase of virtual geographic space.


Agricultural producers often sell a significant part of their crop soon after harvest in order to obtain cash to cover expenses and other financial obligations. At that time, the prices of the harvested products are most likely lower than later in the season. With efficient financing, farmers do not need to sell their product immediately after the harvest to obtain cash. If goods (in storage) can themselves become a vehicle for obtaining credit, pressure to sell will be greatly reduced.

An electronic cash market can act in a broader range of ways to stimulate trade in the commodity sector. This may be through the use of cash or ‘spot’ trade for immediate delivery, forward contracts on the basis of warehouse receipts or the trade of farmers’ repurchase agreements (repos). The extent to which prospective enhancements are delivered in large part depends on the choice of services offered and the strategic priorities that are pursued. The access to ‘bridge financing’ will facilitate in reducing bargaining inequality in the transactions. 

Published in The Economic Times

Need a Standard Solution for Insuring International Commodity Traffic

During the transport or storage of commodities, the cargo is exposed to various risks, depending on the type of commodity and means of transport. There are no standard solutions for insuring international commodity transactions. Each transaction is more or less unique. 

Then there is the ongoing impact of piracy which, while centered in Somalia, is again spreading to other parts of the world. Piracy restricts free trade and has direct implications for vessel operators and their crews, cargo owners, shippers and insurers. The consensus of opinion is that the menace of piracy will be around for a long time. Discussions have now started to focus on shipping and insurance.


The cases of Somalia tend to follow a pattern. The ship crew and cargo of commodities are taken to Somali waters and detained there. The hijacker’s then demand a ransom. Typically the pirates ask for $3-4million and settle for a ransom of about $1-1.5 million. The ship owners usually control the negotiations via their professional negotiators and pay the ransom at the first instance. The negotiations usually take some time, between 6-8 weeks being the norm before the ship, cargo and crew are released. The hijackers seem to be more interested in the ransom money than trying to sell the cargo or ship.

Sometime back one large vessel and the crew were captured at Gulf of Aden and negotiations started shortly thereafter. The owner of the cargo (a large commodity trading house) argued that the vessel capture has irretrievably deprived of the cargo. Therefore, the cargo becomes an Actual Total Loss (ATL) under Marine Insurance. Alternatively, the trading house filed for Constructive Loss (CTL) on the basis that the actual total loss appeared to be unavoidable so the cargo had been abandoned. An ATL requires that recovery is in fact impossible.

Within a month of the vessel being captured, the owner of the cargo gave a notice of abandonment of the cargo to the insurance company. Just ten days later the ship-owner paid a ransom and secured the release of the vessel and the crew. The vessel arrived at the discharge port almost nine weeks after the hijacking and the cargo was discharged undamaged. By this time the price of the commodity had moved. 

Subsequently, the insurance claim filed by the trading company reached the judicial quarters. It was pronounced in the judgment that the trading company had lost only possession and not the property of its cargo. Therefore, the claims are not admissible. The ransom payments are considered illegal. However, the ransom payment under this case was considered as recoverable as sue and labour expense. This throws a wider issue whether a depositor having insurable interest in commodities should abandon a cargo or wait till the carrier/custodians bow to the pressures of ransom payment. Is ransom payment not contrary to the general standards of public policy? 

On similar lines if a vehicle in India, carrying commodity is hijacked at any of the disturbed areas, should the owner of the good or the transporter pay the ransom amount and charge it off as recoverable labour expense or file a claim under an insurance cover? 

Published in The Economic Times

Bank Help Must for Warehouse Receipts’ Success

The overall efficiency of the commodity market, particularly agribusiness, will be greatly enhanced when producers and commercial entities are able to convert inventories of agricultural raw material, intermediate products or finished products into readily tradable products.

Some international collateral managers prefer to issue their own, non-negotiable receipts as part of “guaranteed total performance” packages, which they back with liability and indemnity insurance. It could be argued that the real value of such insurance will emerge only when a really huge claim arises as the insurance cover is only as good as what is stated in the policy document. In the United States, WHR (warehouse receipt) is a document of title supported by legislation, US Warehouse Receipts Act of 2000, which replaced a legislation enacted in 1916. By contrast, in the United Kingdom, a warehouse receipt is a non-negotiable instrument. In the UK, a negotiable form is represented by a warehouse warrant of the type issued by LME-nominated warehouses.

One of the important objectives of WHR in India is to make small farmers (cultivating less than two hectare and constituting about 80% of farmers) behave in a more commercial manner and move in the direction of producers/ entrepreneurs with larger holdings. This would also develop small and intermediate traders into larger and more versatile entrepreneurs expanding operations from localised trade to regional cross-border trading (and in some cases, international export markets).

A focus on establishing a supporting ecosystem like producer’s companies is needed in order to ensure consistent grades and adequate flow of product into licensed warehouses. A majority of higher-value commodities such as rice, wheat, maize, oilseeds and plantation crops come from small farmers. These small farmers tend to feature an unacceptably wide range of product quantity and quality, delivered to the warehouse. WHRs can also be used for government intervention in agricultural markets, which usually has two objectives: to support prices by buying directly from producers and to guarantee a measure of food security. In order to support prices, a government can accept warehouse receipts when prices drop below a support floor rather than taking delivery of physical inventories, a system similar to the loan rate system used in the United States till early 90s.

Since warehouse receipts guarantee the existence of stocks, governments can achieve their food security objectives by merely holding these receipts. The private sector can be made responsible for purchasing, storing, and disposing of the physical stocks. By this way, while the government can play a larger role in macro welfare of citizens, the private sector can focus on the efficiency of the operating system.

While there is confusion and insistence to mention quality specifications on the face of WHRs, those aware with documentary credit will appreciate the similarity of WHRs (issued by warehouseman) with a bill of lading (issued by a shipping company). The custodian of the goods may not necessarily possess the expertise to evaluate the quality of the stored commodities and in some quarters quality certification when issued by a custodian is considered as a conflict of interest. Therefore, by bringing in the element of quality of goods in a document of title would impede its commercial takeoff. A quality certificate from a reputed lab as enclosure will simplify the matter. On the other hand, WHRs need not be equated with a bill of exchange, which is a negotiable instrument in the strict legal sense that passes by mere delivery to a bona fide transferee for value consideration without regard to the title of the parties who make the transfer.

Last but not the least, trust shall be the major cornerstone for the success of a warehouse receipt in India. One of the most difficult keys to overcome is establishing 100% support from financial institutions. The WHR initiatives must develop a strong and viable support system among financial institutions (banks and non-banking institutions) to be successful. This can be accomplished by identifying the service providers which will attract widespread trust among financial institutions.

Published in The Economic Times