Beyond prices: How commodity volatility changes the economics of financing trade

In the commodity trade landscape, volatility can significantly impact financing arrangements. Consider a scenario where a trader in Indonesia agrees to deliver thermal coal to a power utility in another country. On the surface, the transaction appears simple. However, several obstacles can arise, even when the buyer has the funds available.

Firstly, the seller may only release half of the remittance upfront due to local foreign-exchange requirements, with the remainder pending. To mitigate this, the trader may demand a letter of credit, which introduces its own set of complications.

Several lenders have ESG (Environmental, Social, and Governance) restrictions on thermal coal, making it challenging to secure financing. Additionally, the final buyer, a power utility in a different country, requires a thorough assessment of creditworthiness and country risk factors before agreeing to the deal. The financing is structured on the trader's balance sheet, taking into account their scale and reputation.

The article highlights the recent fluctuations in commodity prices, with Brent crude oil rising from $61 a barrel in 2026 to $118 in the first quarter. Urea prices surged from around $400 per tonne to over $850 in April before falling to $453 in June. Similarly, the US iron and steel scrap price index increased by 11.4% year-on-year in July, experiencing significant monthly fluctuations. These price movements do not remain isolated within a single market; they can spread across various sectors.

Geopolitical factors also play a crucial role in commodity price volatility. For instance, Indonesia, the world's largest thermal-coal exporter, can be affected by disruptions in West Asia, leading to widespread impacts on crude, fertilizers, and petrochemical feedstocks. Furthermore, policy changes in origin countries like Iran and Egypt can disrupt fertiliser supply and pricing.

Even an agricultural industry disruption, such as a reduced pistachio crop in California, can have a ripple effect on downstream industries like ice-cream and confectionery manufacturers.

Commodity finance is not merely a loan against goods; it involves managing four types of risks: credit risk, commodity risk, price risk, and currency risk. Credit risk originates from the buyer's financial strength, payment history, and reputation. Commodity risk pertains to the product itself, considering factors such as perishability, storage duration, quality fluctuations, and the existence of alternative buyers.

Price risk is a significant concern even when goods do not spoil, as their value can change rapidly while in transit or storage. Currency risk arises when transactions involve different currencies, and Indian banks may prefer financing manufacturing and processing activities due to better visibility of assets and value addition. European lenders, on the other hand, are more experienced in financing pure trading operations.

In essence, the required financing is determined by the product's price, volume, and time. A fixed credit line does not automatically adjust when commodity prices rise; instead, it may result in financing fewer tonnes of goods. Additionally, extended shipping, inspection, or buyer payment times can further tie up funds for extended periods. Conversely, falling prices can lead to a decline in the value of collateral offered, necessitating additional cash or security from the borrower.

To effectively manage commodity finance in volatile markets, structures must be flexible and adaptable. Lenders and businesses must be prepared to assess the potential impact of origin policy changes, currency weakening, cargo delays, buyer payment delays, and price fluctuations during the delivery process. While it is impossible to predict every potential shock, creating enough visibility, controls, and liquidity within the financing structure can help absorb and mitigate these risks.

Ultimately, the profitability of a trade is contingent upon its ability to be financed successfully, as a profitable trade that cannot secure necessary financing is not truly viable. The author of this piece is the Founder and CEO of Globizera, a Dubai-based bespoke working-capital solutions provider catering to companies across Southeast Asia, the Middle East, and Africa.