(September 19, 2013) – A new IHS report, The Role of Banks in Physical Commodities, provides a comprehensive framework for understanding the current role of banks in the commodities sectors of the U.S. economy. The report includes an overview of the role of financial intermediaries in physical commodities in providing access to capital and risk management services, including hedging against price risks.
The report draws on the multidisciplinary expertise of IHS and includes five illustrative case studies to provide insight into the current role of banks in commodities markets including:
Market making and market liquidity
Enabling efficient price formation
Risk management solutions
Financing of infrastructure and projects
Facilitating industry competition
The report also includes a review of the interplay of physical and financial markets, including how the participation of banks in physical markets relates to the providing of hedging against price changes and other risk management services for energy producers and consumers.
“The report provides a comprehensive view of the role that banks play in the efficient functioning of markets and in providing services essential to industry,” said Kurt Barrow, IHS Vice President, Downstream Consulting and lead author of the study. “It is a complex and important role and one that is not commonly understood. It helps bridge the differing needs of different companies, facilitates investment and contributes to the smooth functioning of markets.
Price risk is a key concern for participants in the commodity sector, whether buyer or seller,” Barrow added. “The ability to hedge against adverse commodity price movements improves the ability of companies to operate, and invest and grow – and in some cases is essential for survival.”
The Role of Banks in Physical Commodities explores how banks provide liquidity in commodities markets through market making activities, bringing together buyers and sellers with different needs and different timeframes. The report examines how the ability of banks to participate both in financial and physical markets enables them to contribute to market liquidity and stability, and to meet the needs of diverse companies, consumers and the overall U.S. economy.
The report examines how bank services can be especially important to smaller and mid-sized companies that do not have the in-house cash flows, expertise or risk-management capabilities on the level of larger competitors. Energy and other commodities industries are capital intensive. This makes it important to be able to raise capital easily and cost-effectively, for example through project trade finance—whereby the commodity is utilized for collateral—that often requires banks to participate in physical commodities markets, the report says.
The report also reviews how the curtailment of these roles for banks would impair liquidity, increase risk for market participants, reduce energy investment and make supply disruptions more likely.
The five case studies highlighted in the report illustrate the functions of banks in such situations as preserving refining capacity on the U.S. East Coast, helping an airline protect itself against high jet fuel prices, facilitating natural gas development by independent companies, the preservation of non-ferrous metal production capacity during steep economic decline and enabling a major wind project in Montana to be built.
Bank services are significant not only for traditional commodities, like oil, natural gas and metals, but also for new commodity businesses such as the wind industry. “These combined physical and financial commodity trade activities are essential for banks to service wind farm developers,” says the report.
“These industry case studies, which encompass a diverse set of essential and commonly-used functions, illustrate the real-world value of combining physical and financial commodity activities,” Barrow added.
The Role of Banks in Physical Commodities was commissioned by The Securities Industry and Financial Markets Association (SIFMA). IHS is exclusively responsible for the content of the report.
IHS (NYSE: IHS) is the leading source of information, insight and analytics in critical areas that shape today’s business landscape. Businesses and governments in more than 165 countries around the globe rely on the comprehensive content, expert independent analysis and flexible delivery methods of IHS to make high-impact decisions and develop strategies with speed and confidence. IHS has been in business since 1959 and became a publicly traded company on the New York Stock Exchange in 2005. Headquartered in Englewood, Colorado, USA, IHS is committed to sustainable, profitable growth and employs approximately 8,000 people in 31 countries around the world.