New opportunities in structured finance of commodities

Structured commodity finance is a sophisticated commodity-based method of trade finance that is used exclusively to finance transactions involving the import, export or foreign trade of commodities for commodity producers and commodity trading companies who do business in developing markets.

Structured commodity finance applies to three main commodity groups: metals and mining, energy and soft commodities. It adds value to the deal life cycle because of the built-in ability to provide maximum security to all the parties to a transaction – the producer, trader and lender – essentially by converting payment and sovereign risk into performance risk.

Supply chains in bulk commodity trade finance

The prices of commodities have soared, but this can only partly be ascribed to increased stimulus spending, production cuts, and geopolitical events.

Commodity finance is a sector that underpins the movement of the world’s raw materials and is a process that links almost all global trade and development. The world’s essential commodities are typically moved in large quantities, involve complex operations and have high notional values. This makes the various layers of finance a critical component in the process that enables the links between producer and consumer.

Historically, regulatory constraints on bank lending to smaller, specialist players, have uniquely positioned large financial institutions and major commodity corporations to be the source of credit needed to finance the flow of trade.

However, this had further effects across the supply chain as small- and medium-sized traders became reliant on financing from major commodity corporates. The combination of circumscribed sources for liquidity and a finite amount of dollars across a global supply chain has also contributed to pressures on supply.

The need to increase storage of essential commodities will continue to ensure stocks are in good shape for the cold months, industry can continue to function, and food sources are available. In times of high prices and regulatory burdens, the need for more liquidity in the market and a shift from global sourcing to regional sourcing will be crucial to free up the movement of these essential commodities. The market is adapting: new commodities flows are being established and energy and food security policies are being implemented. The major players have been through these situations many times over the last century. Their expertise in navigating these volatile times should not be underestimated.

The rise of blockchain in the supply chain

The use of blockchain technology is being implemented to relieve supply chain constraints affecting the commodities markets. From increased security and visibility to tracking complex variables related to sustainability and ethical sourcing, blockchain is helping organizations in all industries lower their costs and improve performance while driving greater value for their companies.

Among the uses of blockchain in the supply chain: supply chain management, identifying opportunities for cost efficiency, regulating product recall, reducing counterfeiting, maintaining ethical standards, logistics, supplier payments, food safety, and post-sale services.

Over the last year, companies across a variety of industries have already put blockchain’s capabilities to good use within their own supply chains:

• a courier delivery service company has integrated the blockchain to improve traceability and provide a trustworthy record, helping to address customer disputes
• one of the largest producers and distributors of diamonds is using the blockchain’s tracking technology to monitor the source and process of every diamond they mine
• a multinational retail corporation has taken a serious interest in blockchain, piloting multiple programs headed with blockchain initiatives, from tracing the origins of mangoes in the US to tracking pork sold in its Chinese markets, it is leveraging the blockchain to improve supply chain visibility and traceability.

In addition to the unilateral implementation of blockchain capabilities, companies across the world are collaborating with one another and using blockchain to improve their supply chain management including, one of the world’s leading energy producer’s collaboration with a multinational technology company to launch a program which tracks oil from the oil well right to the customer; a global merchant and processor of agricultural goods’ collaboration with Dutch and French banks to carry out a blockchain trade of a cargo of US soybeans to a retailer in China, which the company deemed cost-effective and successful; and a direct trade coffee company who took initiative to ensure the economic equality for women in Kenya in its production chain and utilized blockchain to enable better tracking of production and facilitated payment for all women coffee producers.

Leveraging Data and Technology to drive efficiency in the Supply Chain

Throughout the supply chain companies have begun to implement technologies that learn from data, such as artificial intelligence and machine learning, to promote efficiency within commodities markets. The usage of data and technology to identify potential efficiencies has become critical to increasing transparency, optimizing supply chain planning, and identifying cost-saving opportunities. Some of the uses of artificial intelligence and machine learning include: identifying opportunities to reduce energy consumption, automating time-consuming tasks, increasing the accuracy of demand forecasting, developing planning models, and building out organizational capacity, as well as risk-management frameworks.

Here are a few examples of artificial intelligence and machine learning within the supply chain:

• a multinational IT company launching an artificial intelligence based platform that optimizes and automates processes identifying supply chain disruptions
• several European startups developing AI- based applications that analyze energy consumption and identify cost-saving opportunities to reduce such consumption
• a medium-sized supplier leveraging machine learning to improve demand forecasting to determine how their products will be sold at the consumer level.

A global and regional shift in financing the supply chain

The increased susceptibility of commodities markets to both short- and long-term volatility has mobilized a variety of actors to prioritize financing within commodities markets. In December 2022, for instance, Germany’s export credit agency backed a USD3 billion loan to support the delivery of gas into the European grid. However, it’s not just regulators that are working to deliver a much-needed injection of liquidity to the commodities markets. With big banks shifting their focus to large, top-tier commodity traders in recent years, the emergence of alternative sources of financing, such as hedge funds and venture capital firms is becoming a potential solution for small players.

For additional information on this and related subjects, please contact DLA Piper’s Commodities practice at DLAPiperCommodities@us.dlapiper.com.