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Joint Endeavour

CommoditY insights
Yearbook 2010
A bAnk of ExCLuSIvE knowLEdgE And InforMAtIon on CoMModItIES ECoSyStEM

Global Products
Global Practices


About Commodity Insights

The idea behind Commodity Insights, a bank of exclusive knowledge and information on commodities ecosystem jointly published by the Multi Commodity Exchange of India and PricewaterhouseCoopers, is to provide readers/users (economic stakeholders like traders, processors, consumers, financial institutions, policymakers, analysts, industry observers, academicians, and students) with rare insights into the commodities ecosystem. This is our small second step in making this yearbook a benchmark resource spreading knowledge and providing very useful market information in one place in a novel way: presenting useful data related to commodity markets in an easy-to-use way and a rich repertoire of analytical articles to portray an all-inclusive, up-to-date and lucid exposition of a range of issues and concerns that are of paramount importance to healthy development of the entire ecosystem. The focal point of the second edition, Commodity Insights Yearbook 2010, is Global Products, Global Practices. Towards this goal, we have sought to achieve keen involvement of internationally acclaimed authors who all are experts as well as prolific writers in their respective domain, especially in the areas of policymaking and ideation. Besides, our value-adds this year will include specific case studies on oil hedging and metals price risk management, data on BRIC economies, data giving a broad perspective global economy, etc. The yearbook, we promise, will be truly useful to all stakeholders as a year-long, one-stop reference material. A fascinating and engaging read too!

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About PwC
PwC refers to the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity committed to working together to consistently provide clients seamless services of high standards, giving PwC a competitive edge. More than 161,000 people (over 6,000 in India) in 154 countries across the PwC network share their thoughts, experience and solutions to develop fresh perspectives and practical advice. The 130-year old Indian firm PricewaterhouseCoopers Pvt. Ltd. ( is the oldest and largest professional services firm that offers a comprehensive portfolio of Advisory and Tax & Regulatory services, each presenting a basket of finely defined deliverables. With a global outlook and local knowledge of culture, laws and business needs, PwC through its solutions to the challenges of globalization helps clients in India make the most of the changing market scenario. In India, PwC has offices in nine cities Ahmedabad, Bangalore, Bhubaneshwar, Chennai, Delhi NCR, Hyderabad, Kolkata, Mumbai, and Pune.

About MCX
Multi Commodity Exchange of India (MCX) is a demutualised commodity exchange with permanent recognition from the Government of India to facilitate online trading, clearing and settlement operations for commodity futures markets across the country. Since its inception in November 2003, millions of small and medium enterprises, corporate houses, exporters, importers and traders have benefitted from this nationwide electronic trading platform through its efficient and transparent price discovery and price risk management. MCX is the sixth largest commodity exchange in the world and ranks No. 1 in silver, No. 2 in gold and natural gas, and No. 3 in crude oil and zinc futures trading (by the number of contracts traded), according to FIA and data on exchanges websites.

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Foreword ....................................................................................07 From the Editorial Desk ................................................... 08 Market Commentary: Commodity Markets Poised to unlock value for the stakeholders ...............................................................................10 Experts Views: Commodity Exchanges: Role in a Globalising Economy - Jeffrey M. Christian .................................................................18 Lessons from the Crisis: Future of Financial Regulation and Global Imbalances - Partha Ray .................................22 Inter-Relation between Different Markets Lessons for Commodities - Adam Gross ...................................................38 Price Risk Management Instruments in Agriculture - Panos Varangis ........................................................................ 46 Commodity Exposures Best Practice Treatment for Hedge Accounting - Blaik Wilson........................................ 52 Carbon Markets: The Post-Copenhagen Scenario - Pamposh Bhat .......................................................................... 60 Mumbai as an IFC Role of Commodity Exchanges - Ashima Goyal ..........................................................................30

Every effort has been made to ensure the high quality and accuracy of the content of the Yearbook. Under no circumstances, MCX and/or PwC shall not be liable to any user for unintended/accidental errors. The opinions/views expressed and shared by domain experts/authors in all documented materials are their own and do not necessarily reflect those of the organisations/institutions they bear allegiance to, MCX, or PwC (the views shared by Jeffrey M. Christian, MD and Founder - CPM Group, are both his and the Groups). Users/readers may carry out due diligence before using any data/information herein; neither MCX nor PwC will be responsible for any discrepancies/disputes arising out of such use.

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Weather Derivatives: A Key Tool for Mitigating the Impact of Climate Change Rajas Parchure ................... 64 Metal Price Risks A New Reality - Jeffrey Bollebakker &
Arnab Ghosh ................................................................................70

Special Feature: Currency Futures - A Key to Managing Exchange Rate Risk .....................................................................................58 Market Data for Ready Reference: Indian Economy - An overview ...........................................92 Non-Agricultural Commodities .........................................132 Agricultural Commodities ................................................. 226

Gas Pricing in India Changing Contours - Deepak Mahurkar ....................................................................78 Emerging Commodities Managing Price Risks for India Inc - Pankaj Chandak .....................................................86

All rights reserved. No part of this publication may be reproduced, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, without explicit prior permission of MCX or PwC.

A PwC & MCX Joint Endeavour | 5

Tel. :

+91-11-23782807 +91-11-23070121 Fax : +91-11-23384716 e-mail:

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Dated 5th August, 2010

Currently, in the wake of the global financial crisis, markets in most economies around the world are undergoing a makeover primarily in terms of the much needed transparency and robust flow of information a rigorous exercise towards appropriate oversight and regulations. In this context, Indian markets find themselves in a much safer and solid ground largely on the back of the prudence demonstrated by our policymakers through their strategy of gradual and phased policy of liberalisation and globalisation over the years. In sync with our governments vision of enabling domestic markets to graduate to the stature of price setters in the international marketplace and the countrys economy to emerge as a powerhouse on the global economic canvas, domestic markets have witnessed a phenomenal growth in their new pan-economic, electronic and demutualised form during the past six years. Our governments vision and policy approach found strong support in the form of enormous catalytic efforts undertaken by the market regulator, intermediaries, and the national online multi-commodity exchanges as they embarked upon a slew of initiatives to augment financial literacy through frequent awareness-generation and outreach programmes. This, along with trading of innovative commodity derivative products on these exchanges globally-competitive, efficient platforms made this remarkably fast growth possible. As a result, the total value of commodities traded on domestic futures exchanges has over the past six years witnessed 60-fold jump to Rs.77.65 lakh crore as it stands today. In volume terms, the trade has surged at a CAGR of 97.9% in the same period. If, as per the stated vision, our domestic markets are to catapult India to the stature of a price setter at the international level from its current position of price taker and our economy to the hallowed position in the global economic landscape it deserves, then our markets must have both an efficient price discovery and an effective risk management mechanism in place. Again, efficiency of price discovery and effectiveness of risk management in the marketplace are the function of a uniform and transparent flow of appropriate information on the fundamentals and other price-moving factors of commodities through wide participation of ecosystem-wide heterogeneous players. This in turn calls for continuous promotion of market research and efforts aimed at dynamic collation and secure maintenance of data and information. In this context, the joint endeavour of the Multi Commodity Exchange of India (MCX) and PricewaterhouseCoopers (PwC) aimed at promoting market research and information-building processes in the countrys commodity ecosystem in the form of a commodity yearbook is an extremely laudable effort indeed. I congratulate both MCX and PwC on the release of the second edition of the compendium, which, I am sure, would contribute its bit towards achieving the lofty objective that we all as the stakeholders of this strongly emerging economy aspire for. I wish Commodity Insights 2010 a grand success.

Rajiv Agarwal Secretary (CA)

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Reaching Out
n our continued commitment to enriching the commodity markets ecosystem, it is our pleasure to have joined hands once again to bring out the second edition of Commodities Insights Yearbook. In line with the Multi Commodity Exchanges stated focus on global commodities and global practices, we have reached out to some international experts, specialists in their respective domains, to contribute

to enrich the Ecosystem

to the first part of the yearbook dedicated to continuous knowledge sharing and enrichment. The result of this knowledge delivery process is inside for all stakeholders to read and benefit from. The experts contributions cover multiple dimensions of commodity markets, from risk management in commodities/ verticals to global best practices in markets and among their heterogeneous stakeholders to the role commodity exchanges can play in making Mumbai an International Financial Centre. Thanks to the warm response various ecosystem stakeholders and the users of this yearly compendium have extended to our endeavour with their candid feedback, we have taken sincere efforts to provide an increased number of useful data sets on commodities and improve

Standing (from left to right): Mr. Niteen Jain, Mr. Sujan Bhattacharyya, Ms. Vidya Shintre, Ms. Dhwani Mehta, Mr. Nazir Ahmed Moulvi, and Mr. Debojyoti Dey. Seated (from left to right): Dr. Kiran Karande, Ms. Carol Daver, and Dr. V. Shunmugam

the overall quality of the book based on their feedback. Having won several credentials in its journey to becoming Indias largest and the worlds sixth largest commodity exchange, driven by its strategic partnerships with various ecosystem players, it was time for MCX to focus on creating a global benchmark platform with worldwide-traded commodities, which would follow global benchmark practices to provide domestic economic stakeholders with a costeffective platform to mitigate the forces of international commodity fundamentals in Indian time zone. PwC, which services clients the world over in their efforts towards price risk management of globallytraded commodities, becomes MCXs natural partner in this joint endeavour aimed at enlightening market participants, academicians, corporations, and policymakers with prices and the fundamentals that shape them. We firmly believe that this effort of ours will help all these stakeholders with appro-

priate guidance in their future decisions ranging from personal consumption to national economic policymaking. In our bid to reach out to a wider base of stakeholders and give them access to the yearbook than the limitation of a printed edition allows us to, we have already hosted the electronic version of the first edition of Commodity Insights on the exchange website, www.mcxindia. com. It draws an average of 411 visitors everyday and has attracted nearly 56,680 hits since it was uploaded in May-end. To inform those who are new to this joint endeavour of MCX and PwC, the first issue was released on October 14, 2009. We would like to thank Mr. Jignesh Shah, Vice Chairman MCX; Mr. Lamon Rutten, MD and CEO MCX; Mr. Parveen Singhal, DMD MCX; and Mr. Kumar Dasgupta, Partner Price Waterhouse; for their continuous encouragement and support without which this initiative of ours would have remained unaccomplished. We also would

like to thank Sujan Bhattacharyya, Niteen Jain, Nazir Moulvi, Dhwani Mehta and Debojyoti Dey, all from MCX, and Dr. Kiran Karande from Price Waterhouse for their relentless efforts, day in and day out, without which our idea would not have taken the shape of this book. It is our pleasure to acknowledge the work of summer interns from SCMHRD, Pune Ms. Arshika Mishra, Mr. Ankit Dua and Mr. L. Deepak on updating the data sets published in the 2009 edition. And finally, this message from the editorial desk will not be complete without thanking Ms. Carol Daver and Ms. Vidya Shintre who helped gather financial support for packaging this idea of ours in a most presentable manner. You may share your views, thoughts, and suggestions with us at, or at the email addresses provided below; this surely will help us enrich Commodity Insights even further in future attempts. Hope, you find this edition worth referring to, time and again.

V. Shunmugam Chief Economist Multi Commodity Exchange of India

Dr. V Sunmugam

Kumar Dasgupta

Dr. V Sunmugam

Kumar Dasgupta Partner Price Waterhouse

Kumar Dasgupta

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Commodity Markets
Poised to unlock value for the stakeholders
With gradual realisation and acceptance by economic stakeholders that in order to take necessary commercial decisions, they have to factor in global (not just domestic) availability and prices of commodities, there has also been a tacit recognition of the necessity of protecting commercial operations from the risks posed by high price volatility at the international level. An Ernst and Young survey in 2008 found that there has been an overwhelming recognition of risks stemming from commodity price fluctuations and, thus, of the importance of hedging of inputs at pre-fixed prices as a risk-mitigating strategy. However, our markets, which are mature enough to unlock values for the stakeholders, now need an enabling environment that is based on imaginative and bold policy agenda.
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or reasons with multiple implications, commodities have been in the news for much of the period since Commodities Insights made its appearance last autumn. Although much water has flown since then, commodities with their varied economic dimensions have come to visit us more often, at times with a greater force than before. With globalisation of the Indian economy, nearly all its players from tractor-driving farmers to jet-flying corporates are getting exposed to the vagaries of international fundamentals affecting commodities that they are concerned with. Whether the Indian economy is truly decoupled from the forces driving economies elsewhere in the world or not, particularly during a crisis scenario like the current one, our


domestic commodity markets, undeniably, are linked to the global fundamentals of demand, supply, policy actions and market expectations much more now than ever before.

New global risks and increasing recognition of hedging

With gradual realisation and acceptance by the countrys economic stakeholders that both global availability and prices of international commodities have to be factored in, to take the necessary production and other commercial decisions, there is also a tacit recognition of the necessity of shielding their commercial operations from risks posed by commodity price volatility at the international level. A 2008 survey by Ernst and Young (E&Y) across a broad range of Indian companies found that there has been overwhelming recognition of the risks arising out of commodity price fluctuations and, thus, that of the importance of hedging of inputs at pre-fixed prices as a risk-mitigating strategy as per the responses of most of the surveyed lot. Yet, protection against adverse commodity price movements is viewed more as a tactical measure than as a strategic device to manage risks. The effect of price volatility of various commodities on corporate bottom lines was amply demonstrated by a recent study carried out by a prominent Indian business daily. The study used quarterly results of over 1,500 manufacturing firms, which indicated that expenses on raw material had increasingly eaten away a higher share of the otherwise healthy performance of their sales.

As the table shows, raw material expenses, which had, in fact, declined by 3.19% in December 2009, increased by 59% in March 2010 and 28 percent in June 2010 for this large sample of companies. The expenses also consistently accounted for more than half the sales since March 2010. Consequently, net profits of these companies have been falling consistently over the past three quarters. And this is despite their net sales successfully weathering adverse world economic conditions to post robust year-on-year growth. Perhaps the companies could do pretty little to reduce their raw material bill. But what they could have definitely done is to arrest

institutional environment that could promote risk management culture among them. A similar survey of 1,100 companies, after their March 2010 quarter results were announced, was conducted by another publication. The combined net profits of these companies showed a marked increase of 28.5%, year on year. However, if the commodity companies (merely 155 in all) were left out, the net profits of the rest fell by more than 9 percentage points to 19.8%! Conversely, the quarterly profits of these 155 commodity companies grew by more than 103%, Y-o-Y, in March 2010, proving the dichotomous effect of commodity prices on corporate bottom lines.

effect of commodity prices on corporate bottomlines

Heads June 10 Rs. /crore % change over June 09 418,814 210,731 50.32 43,419 23.07 27.63 1.80 11.48 March 10 Rs. /crore % change over March 09 448,346 235,468 52.52 47,649 30.09 58.94 9.53 40.92 December 09 Rs. /crore % change over Dec. 08 401,200 159,284 39.70 48,218 19.18 (-)3.19 (-)9.17 67.40

Net sales Raw Mat. Expense Raw Mat to sales (%) Net Profit

Source: Capitaline

the impact of commodity price volatility and, by extension, the volatility in their net profits. As the table shows, increases in net profits gyrated wildly from 67.40% to 11.48% during the last three quarters. Evidently, a robust risk management tool like commodity futures trading to hedge against such volatility could have enabled them to lock in input costs at predetermined levels. This, sadly, was not done to the desired extent by these companies, a result of failure to take risk management from tactical to strategic levels by their management. What also added to their woes is lack of a policy and

For an economy trying to wither the effects of the recent financial crisis on its foreign trade prospects, commodity price volatility has been a double whammy for its agriculture sector in the past one year. Such high volatility is, again, a result of Indian agricultural markets responding to signals emanating from international markets in an increasingly globalised world where rapid strides in information and communication technology (ICT) mean that the smallest news of relevance in the remotest part of the world can have its profound effect felt within domestic markets and that there remains a structural

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correction of prices pending for long. The double whammy is due to volatility adversely impacting food prices and input costs and, thus, the bottom lines of industries using them as raw materials. The state machinery often tries to intervene in the market to cushion both sides of the market by absorbing such volatility often at the cost of the exchequer. The moot point is that risks associated with commodity price spikes and volatility have, in recent times, risen considerably and affected more and more economic entities that are being exposed to risks associated with increasing volatility while being ever more aware of the impact of this exposure on their economic pursuits. While they seek to cover these risks through hedging against commodity price movements, how attractive does the market they approach appear. The E&Y survey found nearly all respondents to hedge through recourse to plain vanilla products alone. Significantly, about 68% of them had a hedging horizon of less than three months, indicating that they could not explore possibilities of long-term hedging to protect long-term business cash flows. Clearly, there is a demand for safe hedging through a variety of hedging instruments, many more than what the market currently provides. While OTC forward contracts can fulfil the demand for customised hedging products, they lack the kind of liquidity and safety that exchange-traded and exchange-cleared derivatives provide. The market for the latter, unfortunately, seems to have run into a wall as the supply of To 11.5% Companies net profits gyrated, as wildly as this, in the past 3 quarters. Surely, a robust risk management tool like commodity futures could have helped lock in input costs at predetermined levels.

products has scarcely been able to match their ability and needs. The reason, as has been elucidated in several fora by several constituencies in recent years, is the slow pace of policy and institutional reforms for nurturing the use of commodity derivatives by the stakeholders in India.

Healthy market growth in need of policy initiatives

Markets facilitating the trade in commodity-based derivatives in India are regulated under the For-

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ward Contracts (Regulation) Act, 1952, an Act enacted in the backdrop of wartime shortages. Evidently, a market which has grown by nearly 40% in the past four years to become one of the largest in the world (implying its enormous importance for the economy) and its products are reckoned as an investible asset class in the league of stocks and fixed income instruments, needs to function under the ambit of a market-enabling regime than this Act allows. The intended amendment to the Act is yet to see the light of day, despite being at various stages of review by legislators for close to four years. As a result, not only is market development, incommensurate to the level of economic requirement being impossible to be taken up under the existing law but also that integration of the commodity futures market with the physical ecosystem has been left incomplete. The reluctance of both capital and money market regulators to let their regulated entities enter the commodity futures market appears to be for two broad reasons: the lack of clear policy guidelines and the absence of an autonomous regulator for this market. Similarly, denying products such as options and intangibles, which could fulfil the hedging demand of a very large number of stakeholders not the least of who are from the farming community is tantamount to keeping these stakeholders away from an effective risk-mitigating device. That economic stakeholders are more prone to commodity price risks under effect of global forces has been well recognized by now. This has been the biggest contributor to the creation of the demand side of the commodities derivatives market. What has been less appreciated is the tremendous potential

that a fast-growing large economy like India holds in the world of commodities market to get back its ancient price-setting power. Given the size of its population and nature and growth potential of its economy, India is one of the largest producers and/or consumers of most commodities. With liberalised markets both physical and futures - and an accommodative policy regime that promotes new products and market participation from India and abroad, the commodity derivatives market in India can set global benchmarks not only in terms of prices discovered in its markets but also in terms of products and practices. Already, despite being under a relatively restrictive market, the countrys largest commodity futures exchange is the sixth largest in the world, occupying the top position in silver and second position in gold and natural gas. With an accommodative policy, India can definitely be the price-maker rather than a passive price-taker for most commodities in the world market, especially the ones that the stakeholders actively trade in. Such policies would not only include

those that promote futures trading in commodities but also remove the hurdles on the way towards formation of a pan-India physical market for commodities setting up a solid platform for national commodity derivative markets. Today, as we stand at the cusp of history and a generation witnesses the transition of India from a poverty-stricken country to one of prosperity and economic might, the visages of control that inhibit this transition have to be identified and removed. Cynics argue against liberalising commodity markets for a range of imaginary fears, ranging from stoking fires of inflation to securing supplies of key intermediaries. But as our experience with liberalisation (together with similar actions of the other emerging superpower, China) has clearly demonstrated, there is much more to gain through liberalisation of markets and economy than to give into what the phantoms of imagination would lead us to believe. After all, the Indian economy has proven to be robust enough to withstand and emerge successfully from transitions and crises; and markets, under leadership-providing regulators, mature enough to unlock values for the economic stakeholders. What is needed now is only an enabling environment, created by an imaginative and bold policy agenda, so that these values are reaped by all stakeholders to their fullest extent. As American writer Ambrose Redmoon once famously said, Courage is not the absence of fear, but rather the judgment that something else is more important than fear , only some boldness in policymaking and a commitment towards further liberalisation of economic forces can catapult us to the next level of growth

Courage is not the absence of fear, but rather the judgment that something else is more important than fear
Ambrose Redmoon

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