Second Edition
Commodities demystified

A guide to trading and the global supply chain

Commodities trading is one of the oldest forms of economic activity, yet it is also one of the most widely misunderstood. This guide explains the functions and modus operandi of commodities trading firms and their role in organising the global flows of vital materials that underpin economic growth.

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This Glossary is a non-exhaustive list of the key terms used in commodities trading.

Choose a letter


Aluminium oxide, also called alumina, is the raw material required to produce primary aluminium. It is a white powder produced by the refining of bauxite.


Situation where early periods in a price curve are valued at a premium to later periods. This can be a result of short supply or a peak in demand in the short term.
Basis risk
The risk that the value of a derivatives-based hedge will not move in line with its underlying exposure.
The main raw material for aluminium metal production. Bauxite deposits are mainly found in a wide belt around the equator.
Benchmark (crude)
A crude oil specification that serves as a reference price for buyers and sellers. There are three primary benchmarks, West Texas Intermediate (WTI), Brent Blend, and Dubai Crude.
Benchmark (metals)
A benchmark is a measurement of the price per unit of quantity of the underlying commodity traded in the international marketplace. It is set periodically by the country or through negotiation between the major producer and consumer organisations that consistently sell or buy large quantities of the commodity in a marketplace, and is used to serve as a point of reference against which sectors can be evaluated.
Bid / offer
A market maker quotes a two-way price for a commodity with the bid price lower than the offer price. Customers can sell to the market maker at his bid price and buy from him at his offer price.
Bill of lading (BL)
A document issued by the master of a ship when loading is completed. This acts as receipt for the goods, document of title to the goods and evidence of the contract of carriage. The rightful receiver of the cargo presents the BL to claim it at the discharge port.
Blister copper
An impure form of copper produced in a furnace.
The fuel used by ships. The term for fuelling a ship is bunkering.


Call option
A call option gives its owner the right but not the obligation to buy a specific quantity of a given commodity at a defined price up until a certain point in time, in return for a premium.
Charter party (CP)
A contract to charter a vessel.
A company that hires a ship and its crew for a single voyage or for a fixed period.
Security pledged in exchange for a loan.
The tradable commodity created by initial processing of lead, zinc or copper ore. Concentrates are used as raw materials by smelters to produce refined metals.
An ultralight oil found in huge quantities in shale deposits. When underground it is mostly in gaseous form. It condenses into a liquid when pumped to the surface.
A market environment where early periods in a price curve are valued at a discount to later periods. It can be the result of over-supply or lack of demand in the present. This is normally a temporary phenomenon.
Copper cathode
A 99 percent pure form of copper - the primary raw material for copper wire and cable.
The opposite party in a contract or financial transaction.


Deadweight tonnage (DWT)
The cargo-carrying capacity of a vessel, in metric tonnes, plus the weight of bunkers, stores, lubes, fresh water, etc. It does not include the weight of the ship.
The compensation paid by charterers to the owners of a vessel for extra time used at the port, beyond what has been granted under the charter.


The portion of a trader’s position that is subject to the risk of price movement.


Flat position
Having no outright position - either because nothing is held or because long and short positions net off.
Flat price risk
Exposure to a change in absolute prices in a particular market.
Contracts for commodities to be delivered in the future. The product, quality, delivery and quantity is specified. These are traded on exchanges and there is no counterparty-based credit risk. The only variable is price. Contracts are marked to market daily.


Geographic spread
The price differential between commodities with the same quality and grade characteristics deliverable on the same date but at different locations.
Refined petroleum products, especially gasoline, that exceed a required specification.


A position taken to counteract an exposed position intended to minimise or remove price risk. This is usually achieved using futures contracts and other derivatives.


Initial margin
The per contract financial guarantee required by a clearing house to be able to trade on its exchange.
International commercial terms are trade terms published by the International Chamber of Commerce (ICC). They are commonly used to ease domestic and international trade by helping traders to understand one another.


The amount of time in port granted by the owners of the vessel, as stated in the charter party, for the loading and discharging of cargo.
Letter of credit (LC)
A document from a bank guaranteeing that the seller will receive payment in full, as long as certain delivery conditions have been met.
Letter of indemnity (LOI)
A guarantee that losses will not be suffered should certain provisions of a contract not be met. If a BL is not available, then a letter of indemnity is submitted to the owners for the delivery of the goods instead.
London Metals Exchange (LME)
A commodities exchange in London, England that deals with metals futures. Contracts on the exchange include aluminium, copper and zinc. The LME is a non-ferrous exchange, which means that iron and steel are not traded on the exchange.
Long position
The net position of a trader holding / owning a commodity in the market.


An accounting mechanism that revalues trading positions against current market prices. Profits and losses are realised at each revaluation.
Middle distillates
The range of refined products situated between lighter fractions, such as gasoline, and heavier products, such as fuel oil. They include jet fuel, kerosene and diesel.
Infrastructure that provides alternative transportation modalities for commodities, e.g. road, rail and river.


A flammable liquid made from distilling petroleum. It is used as a diluent to help move heavy oil through pipelines and as a solvent.


Offtake agreement
A long-term supply agreement where a trader agrees to buy a fixed quantity or proportion of a resource producer’s future output at a specified price.
A strategy that may have limited short-term benefits, but confers considerable longer-term value by extending choice and improving contingent outcomes.
Over-the-counter (OTC)
A security or financial transaction conducted away from a formal, centralised exchange.


Posted pricing
A posted price is set by a government or national company where the price is set for a fixed period of time and only reviewed by that pricesetting body.
Premium / discount (metals)
Applied to benchmarks, being the addition or subtraction in price over or under a reference price negotiated between physical trading partners for a specific product, delivery location and date.
Put option
A contract providing the owner with the right but not the obligation to sell a volume of a given commodity at a certain price up until a certain point in time, in return for a premium.


Quality spread
The difference in price between different grades of a commodity deliverable on the same date at the same location. The higher grade commodity will normally trade at a premium.


Reid Vapor Pressure (RVP)
A common measure of the volatility of gasoline. It is defined as the absolute vapor pressure exerted by a liquid at 37.8OC (100 oF) as determined by the test method ASTM-D-323.
Repurchase agreement (REPO)
A contract that operates like a secured loan. The seller of a security simultaneously agrees to repurchase it from the buyer on a specified future date at an agreed price.


Short position
The net position of a trader owing a commodity in the market, often associated with futures markets. They have undertaken to sell a commodity and will need to buy back or cover that position by the delivery date.
A restricted refining process that splits condensate into various products, including naphtha and distillates.
Spot price
The current market price at which a commodity is bought or sold for immediate payment and delivery.


The steel index is a specialist provider of price information for key steel, iron ore, ferrous scrap and coking coal products around the world, based on spot market transaction data.
Time charter
Hiring a vessel for a fixed period. The owner manages the vessel but the charterer specifies journeys, fuel, port charges, etc.
Time spread
The difference in price between a commodity delivered on a particular date and the identical commodity deliverable on a different date. Also known as calendar spread.
Treatment charge (TC) and Refining charge (RC) (concentrates)
TC / RC are amounts designed to cover the cost incurred by the smelter during the smelting and refining process, whereby the treatment costs occur during the smelting process to extract metal from the ore and the refining costs occur during further purification to pure metal where all undesirable by products are removed. They are negotiated fees that may be linked to metal prices as well as market supply and demand, and in the concentrates business usually paid by the seller to the buyer.


Variation margin
Futures contracts are marked-to-market at the end of each trading session. Variation margin refers to the top-up payment required of those holding loss-making positions before the start of each trading session.
Vertical integration
The combination in one company of two or more stages of the supply chain that would normally be operated by separate, specialist firms.
Oil's resistance to flow. Higher viscosity crude oil is much more difficult to pump from the ground, transport and refine.
Volatility (oil)
The speed at which evaporation occurs. More volatile oils have better burning properties, particularly in cold climates, but they also require more active temperature regulation and sealing procedures to protect the environment and minimise oil losses.
Volatility (price)
The degree of variation in a trading price series over time as measured by standard deviation.
Voyage charter
Hiring a vessel for a specific voyage between a load port and a discharge port. The charterer pays the vessel owner on a per-tonne or lump-sum basis. The owner pays port costs, excluding loading and unloading, as well as fuel and crew costs.

Fundamentals of commodities

International trading in fuels, minerals and food has expanded vastly in recent decades. Understand more about physical commodities and the trading processes that have enabled globalisation.

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What are physical commodities?

Physical commodities are the fundamental raw materials that underpin the global economy. They are traded in vast quantities across the globe. We depend on them for the basics of everyday life for the electricity we use, the food we eat, the clothes we wear, the homes we live in and the transport we rely on.

Main types

Primary commodities

Primary commodities are either extracted or captured directly from natural resources. They come from farms, mines or wells (e.g. crude oil).

Secondary commodities

Secondary commodities are produced from primary commodities to satisfy specific market needs (e.g. crude oil is refined to make gasoline).

Commodities for heat, transport, chemical manufacturing and electricity

Commodity categories


Agricultural commodities include grains and oilseeds (corn, soybean, oats, rice, wheat), livestock (cattle, hogs, poultry), dairy (milk, butter, whey), lumber, textiles (cotton, wool) and softs (cocoa, coffee, sugar).


Primary energy commodities such as crude oil, natural gas, natural gas liquids, coal and renewables are refined and processed into many different petroleum products and fuels, from bitumen to gasoline, biodiesel and LNG (liquefied natural gas).

Metals & Minerals

The major base metals mined are iron ore, copper, aluminium, nickel, zinc and lead. Iron ore is left untreated, but mined copper, lead, nickel and zinc ores are turned into concentrates, while bauxite is turned into alumina. Iron ore, concentrates and alumina are traded as primary commodities. Smelters process these into refined metals and useful alloys such as steel.

The structure of the global supply chain

An efficient supply chain promotes prosperity by ensuring smooth transmission of the energy and raw materials that underpin our civilisation. The market-based mechanism aligns supply and demand highly effectively.

The physical supply chain

The physical supply chain is the beating heart of the commodity trading business. Global trading firms manage transportation and complex logistics to source, store, blend and deliver commodities for their customers around the globe.

Supply chain for crude oil / petroleum products

Who are commodity traders and what do they do?

Commodity trading firms play a pivotal role in the global supply chain by bridging gaps between producers and consumers, and balancing supply and demand both within regional markets and at a global level.

Oil trading:
a multidimensional discipline

Commodity traders need excellent peripheral vision to understand the interconnected nature of the global economy. Conditions in commodity markets can change rapidly and traders have to remain alert to many micro and macro factors. Economic cycles, geopolitical developments and technical factors all have an impact.

Trading and transformation

Commodity traders are essentially logistics companies that use financial markets to fund their operations and hedge or limit the price risk involved. They transport, and in several ways, transform, commodities across the world. This notion of transformation is key.

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How commodity trading works

From production through to delivery, commodity traders look for opportunities to transform commodities in terms of how they are transported, stored, blended and processed. Explore how trading firms deliver against client specifications.

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Sourcing commodities: working with producers

Trading firms aim to maximise the price differential between the price they pay for (untransformed) commodities and the revenue they earn by selling (transformed) commodities. Minimising the overall cost of acquiring commodities is therefore a priority. Trading firms work with producers to secure long-term, cost-effective supply.

Ways commodity trading firms secure reliable low-cost supplies

Transporting commodities: transformation in space

Many producers are in remote locations, often in emerging economies. Traders need to deliver commodities to consumption centres on the other side of the world. They can increase their profitability and generate more physical arbitrage opportunities by lowering transportation costs.

Inland transportation

Getting product from one part of the world to another brings many different modes of transport into play. Below are the main inland modes of transportation.

Inland transportation

Overseas transportation

Just as commodity trading firms need onshore facilities to load, offload, store and blend cargoes, so they need ships to carry their cargoes across the oceans. Shipping therefore plays a vital part in commodity trading.

Ship shapes size (deadweight tonnes)

Storing commodities: transformation in time

With inelastic supply and demand in commodity markets, supply and demand shocks have the potential to create very volatile market conditions. Trading firms store commodities to help bridge this gap and keep markets in balance. They own and control midstream infrastructure and maintain large inventories at strategic locations around the globe. Traders earn profits over time by reducing stocks when there is excess demand and building up inventory when there is excess supply.

Contango and backwardation

A trader can buy a commodity for delivery on a date in the future in one of two ways. He could either borrow money now to buy the commodity today, and store it until the desired delivery date or he could buy a commodity futures contract. When futures price drift higher than spot prices, markets move into contango. The opposite situation, when futures fall below the current spot price, is known as backwardation.

Brent futures curves

The brent futures curve moved from backwardation in May 2014 to contango in May 2015 to super contango by November 2015 and back to contango by May 2016.

Blending commodities: transformations in form

To be fit for purpose physical commodities need to match customer specifications. Since commodity producers derive their product from the ground, its quality and characteristics are variable.

Blending in copper markets: the Chinese example

Chinese copper consumption has grown markedly since 2000 making the country the world's largest consumer. The quality of concentrate available has suffered with the growth in demand. As existing mines get depleted, smelters are more reliant on new, sometimes arsenic-rich, sites for their concentrate. This poses health and safety issues. Processing techniques such as oxidisation can reduce arsenic content, but these are costly and they also affect copper levels. Another solution is to blend the concentrate. Mines producing arsenic-rich concentrate sell at a discount to trading firms. Traders blend the material with cleaner concentrates before selling on to smelters.

Blending product to chinese specification

Delivering commodities: meeting customer specifications

As markets become more efficient, commodity trading is evolving into a low-margin service business. Increasingly, traders make their living by providing a solidly reliable logistics service between producer and consumer.

Executing the trade: operations in action

Structuring and maintaining an efficient operating model is at the heart of profitable commodity trading. The operations team has an important role in helping to define and refine protocols that help the trading firm minimise risk and reduce costs.

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Commodity trading, risk
& financial markets

Commodity traders operate on very thin margins and handle huge volumes of product. Sudden price changes could leave them badly exposed. To mitigate these risks, traders use robust risk management and funding strategies. Learn more about risk management and commodity trade finance.

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Managing risk

Risk management is a core competence for trading firms. They store and transport physical assets across the globe and earn slim margins on high-value, high-volume transactions. They use sophisticated risk management techniques to link revenues to costs and operate effectively in volatile markets.

Managing flat price risk

The practice of hedging is fundamental to commodity trading. Trading firms systematically eliminate their flat price exposure by taking out futures contracts against both components of a transaction.

Hedging against flat price risk

Funding commodity trading

Trading firms buy and sell commodities with an aggregate value that far exceeds their own capital resources. They achieve this by attracting funding from financial institutions. Banks are willing to lend because their loans are secured against commodities.

How banks finance trade

Banks facilitate a trade by providing a letter of credit (LC) to the seller on the buyer's behalf. This document is a bank-backed guarantee that the seller will receive payment in full so long as certain delivery conditions are met. The seller has the assurance that should the buyer be unable to make payment on the purchase, the bank will cover the outstanding amount.

Issuing letters of credit (L/C)

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