The Price Has a Body

Before it became a ticker, it was heavy. Every com­mod­ity price on a screen is the price of some­thing that had to be dug up, pumped out or grown, then moved, stored, insured, financed and checked against a written spec­i­fi­ca­tion before anyone would accept it in set­tle­ment of a con­tract.

The first two acts of this issue stayed inside the ter­mi­nal. That is where most people meet prices, and where it is easy to forget that a futures con­tract for crude oil or copper is, at the end of the chain, a promise about a lorry, a pipe­line or a ware­house. This act leaves the ter­mi­nal.

What the con­tract describes

Open the rule­book for a com­mod­ity future and the first thing you meet is a descrip­tion of an object. The price comes later. The New York Mercantile Exchange's light sweet crude con­tract is for 1,000 US barrels, 42,000 gallons, of oil within a range of density and sulphur content, deliv­ered at Cushing, Oklahoma. The Chicago Board of Trade's wheat con­tract is for 5,000 bushels of named grades, deliv­ered by ship­ping cer­tifi­cate at approved ele­va­tors. The London Metal Exchange's copper con­tract is for 25 tonnes of Grade A cathode, from reg­is­tered brands, in an LME-approved ware­house. A London Good Delivery gold bar must contain between 350 and 430 fine troy ounces at a fine­ness of at least 995 parts per thou­sand, from an accred­ited refiner.

Each of those details narrows what the price is the price of. Oil that is too heavy, copper from an unreg­is­tered smelter, or gold from a refiner that has lost its accred­i­ta­tion is still a phys­i­cal object of real value. It is not deliv­er­able against the con­tract, and it trades at a dif­fer­ent number.

What gets added on the way

Follow a barrel from a well in west Texas. Somebody paid to drill and to lift it. A pipe­line company charges a tariff to carry it to a hub. At Cushing a ter­mi­nal charges to hold it in a tank, by the month. Somebody owns the oil while it sits there, and has paid for it with money that has a cost, so storage carries a financ­ing charge as well. It is insured. When it moves on to a refin­ery, it is mea­sured, sampled and tested, and if it is off spec­i­fi­ca­tion the price is adjusted.

A price quoted on a screen for deliv­ery at a hub already con­tains most of those costs, and the dif­fer­ences between hubs are largely the costs of moving between them. The spread between oil in Cushing and oil on the Gulf Coast is, much of the time, a price for pipe­line capac­ity. The dif­fer­ence between copper in a Rotterdam ware­house and copper in Shanghai is a price for freight, duties and time. The ticker shows one number. The body of the com­mod­ity shows where the number came from.

When the body pushes back

Most of the time these costs are small and stable rel­a­tive to the com­mod­ity, and the finan­cial price and the phys­i­cal price move together. Occasionally the body asserts itself. April 2020, on page 23, was one case: storage ran short and the price of taking deliv­ery went below zero. Copper has had the oppo­site problem. When ware­house inven­to­ries on an exchange fall very low, shorts who must deliver metal compete for what little remains, and the nearest con­tract can trade far above later ones.

Gold hides its body better than most. It is so dense that a year of global mine pro­duc­tion, about 3,600 tonnes, would fit in a cube a little under six metres on each side, and it is rarely con­sumed, so almost all the gold ever mined still exists. Yet when demand for gold in New York surged rel­a­tive to London at points in recent years, bars had to be flown across the Atlantic and melted into the kilobar sizes the New York con­tract pre­ferred, and for a while the price gap between the two cities reflected the capac­ity of refiner­ies and cargo holds.

Two oils, one word

The world has two main bench­mark prices for crude, and the dif­fer­ence between them is almost entirely phys­i­cal. West Texas Intermediate is deliv­ered at Cushing, in the middle of a con­ti­nent. Its price reflects what it costs to get oil to and from a land­locked hub, and when pipe­lines out of Cushing are full, WTI can trade at a wide dis­count to oil else­where. Brent, the bench­mark for most of the world's seaborne crude, is based on cargoes loaded from ter­mi­nals in the North Sea, and its price reflects oil that is already next to a ship.

The two are similar in quality and are often both called the oil price. The gap between them has moved from a premium for WTI to a dis­count of more than twenty dollars a barrel and most of the way back over the past two decades, as American pro­duc­tion grew faster than the pipe­lines built to carry it, and then the pipe­lines caught up. Nothing about the oil changed. The plumb­ing did.

Specification does the same work more quietly. Heavier crude and crude with more sulphur is harder to refine, so it trades below the bench­marks by an amount that depends on how many refiner­ies can handle it. When one large refin­ery that runs heavy sour oil shuts for main­te­nance, the dis­count on that grade can widen for weeks. On a screen it looks like the price of oil moved. In a tank it was the price of one kind of oil.

The paper and the metal

Most futures con­tracts never end in deliv­ery. They are closed before expiry, and the phys­i­cal system is only there as a back­stop that keeps the paper honest. But the back­stop is the reason the paper means any­thing. A con­tract that could never be deliv­ered against would be a bet on a number. A con­tract that can be deliv­ered against is anchored, by the threat of deliv­ery, to ware­houses, tanks and ships.

The ticker is the light­est thing in the chain. It is also the last thing to find out when the chain breaks.