As the commodity trading industry looks back on Q1 of 2023, it is evident that the first three months of the year have been marked by a number of significant events.
Some of the most notable events include interest rate hikes by central banks worldwide battling inflation, persistent disruptions to global supply chains caused by the ongoing Russia-Ukraine war, banking sector instability, and recovering business activity in China as it ends its strict COVID-19 restrictions.
In addition, the industry has had to contend with shifting consumer demands and evolving regulatory frameworks, all of which have introduced new challenges to a rapidly volatile and unpredictable market landscape. However, while the industry has shown resilience in the face of these challenges, recent events have exposed substantial business risks.
This article will highlight the major risk factors that have emerged in the commodity trading industry in Q1 2023, and assess their potential implications for businesses.
1: Credit risks – using a multi-pronged strategy to stay resilient
The recent instability in the global banking sector has raised concerns about the potential contagion effects on commodity trading. As banks face increasing pressure from rising inflation, interest rate hikes, and mounting bad debts, they may become more cautious in their lending practices, leading to reduced liquidity and increased borrowing costs for commodity traders.
Furthermore, the failure of major financial institutions – as witnessed by the recent banking turmoil in the U.S. and Europe – could have severe knock-on effects on the wider financial system, disrupting the flow of credit and increasing counterparty risks for commodity traders.
To successfully navigate trade finance risks in the commodity trading industry, businesses should consider adopting a range of strategies. These may include diversifying financing sources, carefully managing counterparty risk, working with multiple financial institutions, and maintaining robust collateral management practices.
In addition, businesses may want to consider leveraging technology solutions, such as blockchain-based platforms and digital supply chain financing, to streamline trade finance processes enhancing transparency.
2: Persistent geopolitical and sanction risks
The Russian oil price cap regime has presented challenges not only for energy trading companies but also for the maritime and shipping industries. Compliance risk is of particular concern, as violating sanctions or regulations related to the price cap could lead to financial or reputational damage.
For energy trading companies, due diligence measures should be enhanced to evidence compliance with the price cap. Moreover, commercial and freight contracts should be reviewed to include updated terms, especially with the emergence of the dark fleet engaged in sanctioned energy-commodities trading.
Another aspect to consider is for other commodity sectors that rely heavily on Russian crude oil as a feedstock or raw material, as supply chain disruptions could lead to production delays, and increased costs, which may necessitate finding alternative shipping routes or providers at higher costs.
As the ongoing Russia-Ukraine conflict continues well into the year, more stringent sanctions are likely to emerge. Thus, businesses must continually evaluate their business strategy, making practical investments to manage their operations efficiently while maintaining their reputational risk and regulatory compliance.
3: Post-COVID rise in demand and regulatory risk
China’s recent move to dismantle its zero-COVID policy has undoubtedly happened faster than expected. It is expected to drive global economic growth as business activity and consumer spending are poised to return to pre-pandemic levels.
While this is set to create opportunities for commodity traders to meet the increased demand, it also poses potential risks. One such risk is the possibility of supply chain disruptions if demand surges too rapidly, resulting in potential shortages and upward pressure on prices.
A second concern is the regulatory uncertainty that comes with the reopening of China’s economy. Changes in regulatory policies could lead to unpredictability for commodity traders, including changes in trade, tariffs, and environmental standards, all of which could impact the commodities market and introduce additional risks.
In light of this, traders are advised to approach the situation with cautious optimism, carefully evaluating risks and opportunities that may arise in the new normal of China’s zero-COVID policy.
4: Terrifying technology – New cybersecurity risks
As the commodities trading industry becomes increasingly dependent on technology, cyberattacks continue to put businesses around the world at risk. Potential financial loss and reputational damage from data breaches and cyber-attacks are major concerns for commodities traders.
The widespread adoption of technology in all areas of business has led to an alarming increase in the use of advanced technology by cybercriminals. As a result, the cybersecurity measures implemented by businesses are increasingly inadequate and outdated. Organisations must invest strategically in areas such as vulnerability and security management both internally and across their supply chains.
Part of maintaining a high level of safety is ensuring vigorous employee training is in place. This may include regular phishing awareness training and a clear incident reporting procedure.
Additionally, network security, encryption of sensitive data, and regular patches and updates of software and hardware should be tested. Finally, a clear incident response plan, including identified roles and responsibilities, procedures, and communication protocols for informing internal and external stakeholders, is critical to minimising the impact of a successful cyberattack.
Looking to the rest of 2023
The market forecast for 2023 indicates a notable degree of volatility with mixed bullish and bearish sentiments. And while volatility can present opportunities to commodity traders, risk-management complexities will remain substantial throughout the year. Irrespective of the particular sector of the industry, every organisation in the world of commodity trading is inevitably susceptible to these risks.
Thus, establishing risk management frameworks as well as updating existing ones, becomes critical to improving organisational efficiency and safeguarding the organisation’s position in 2023.