Plastics traders and consumers are hoping the launch of a new plastics futures contract in Dubai will offer a useful hedging tool and greater price transparency, ensuring success where London's LME has so far failed.
Soaring prices and recent high volatility have prepared the ground well for an exchange-traded pricing mechanism in the Gulf, which has half of the world's petrochemical projects. Large plastics producers who are integrated into the oil and gas industry may be slow to adopt the new contract, but dealers say smaller players, more exposed to volatility, will be keen to use the Dubai Gold and Commodities Exchange's (DGCX) contracts.
"Integrated plastics producers who don't buy oil from the open market are less concerned about the effect of feedstock prices on their margins, and they think hedging can restrict profits," one industry executive said. "But those who are not in the active Middle Eastern and Asian regions, and are desperate for margin stability, especially in this extremely volatile market, will want to use the DGCX contracts."
Plastics come from oil products naphtha and ethylene but cannot be hedged properly on oil futures exchanges as these markets do not always move in the same way. The bourse hopes to launch four contracts next month in low-density polyethylene, high-density polyethylene, linear low-density polyethylene, and polypropylene.
For each grade, there will be three regional contracts: Northeast Asia, Southeast Asia and the Middle East. "The exchange is fulfilling an important niche that will represent the very large increase in local capacity in the Asian and the Middle East regional physical markets," said David Paul, Barclays Capital's global head of petrochemicals and plastics. Trading in polypropylene and linear low-density polyethylene futures on the London Metal Exchange (LME) started in May, 2005, but volume has been low so far. One difficulty those contracts have faced is "basis risk": differences between LME prices and prices in the underlying market at futures monthly settlement.
The model adopted by the LME relies on the assumption that - whatever the differences between prices on forward futures contracts and the physical markets - prices will converge when the contract expires, allowing traders the possibility of delivering physical lots of plastic to cover futures positions.