Sometimes, you will hear of commodity purchases being made on the "spot market". This term has to do with the commodity market itself, and will relate to the pricing that you receive.
If you haven't dealt much with bulk oil commodities, this term can seem foreign. We will explain, so that you can make smart purchases and understand exactly the pricing that you're getting.
Ever wonder why spot prices are often more expensive than contracted rates? There's a good reason, and we'll discuss that too.
First off, what is a commodity item?
A commodity is a raw material or agricultural product that you can buy or sell. In the bulk oil world, a commodity is an oil that has a fluctuating price that changes on a regular basis. This price is based off of the items availability: how much oil has been produced and what is actually available to buy. The price changes by the minute, hour, day or week, depending on the type of oil.
In fact, most (if not all) of the oils that we sell are commodity oils.
Forward Contracts For Bulk Commodities
Many commodity market items, like soybean and canola oil, are purchased using forward contracts. Bulk oil contracts allow you, as a purchaser, to lock in a particular volume of oil at a particular price. That price is based on what the commodity market is today, and what it is predicted to be in the future.
These forward contracts are often referred to as futures or buying on the futures market. These agreements are quite a bit like dealing on the stock market.
Many purchasers will contract for a years worth of volume of oil, with the regular deliveries scheduled on a weekly or monthly basis. If they find that they use more more oil than they had originally expected, they will have to buy more inventory that they can get delivered immediately. This is known as buying on the spot market.
What is the spot market?
The spot market is simply today's price. There is no futures or contracts involved, and the price is based on just the amount you're buying in that one order.
Let's look at a common example. If you had originally contracted for a years worth of oil and you end up using it more quickly than you had predicted, you'll need to buy more oil to fill in that inventory so production is not shut down. You will buy whatever you need to get you through the next... Week? Month? Whatever you decide based on the current market. Again, when you buy on the spot market, there is no planning into the future and the price does not take into account the normal volume that you use.
Spot commodity market purchases are usually smaller in volume (as compared to annual contracts), and they are a "quick fix" to get raw materials in when you need keep production running.
When do most manufacturers by on the spot market?
There are particular times of year when many manufacturers will be buying on the spot market at the same time. For example, let's look at the safflower oil market. In general, the best time to lock in a contract is after the harvest in the fall, because typically prices are going to be the lowest then. If the harvest season is in October, then that's when most food manufacturers will sign their contract each year.
Purchasing managers do their best to predict the volume that they will need for the next year. However, if their business continues to grow they may run out of the oil that they contracted for early. Say they use up 12 months worth of contracted oil in 10 months time. By August, they will be out of oil and will need to buy on the spot market to hold them over until the next harvest is complete in October, when they plan to sign a new contract.
Because the harvest season in the US is the end of summer/ beginning of fall for many different kinds of crops, the few months before then (June-August) is a common time where many food manufacturers are forced to buy on the spot market.
How Do Spot Market Prices Compare to Contracted Prices?
Because of the above situation, and the typical low supply of oil just before a harvest season, prices are often higher at this time naturally. Unfortunately, this is when many purchasing managers are forced to buy on the spot market to keep their production lines going.
As a result, many spot market purchases like this end up being comparatively more expensive then a year-long contract signed after the harvest.
Of course, spot market purchases don't have to be more expensive – it's just based on the current commodity market, and where ever that may stand.
Topics: Harvest/Commodity Market