The global pandemic and resulting disruption to global trade have savaged the demand and supply equation of the commodities business. Success for these companies in the post-COVID era depends on finding ways to increase their operational resiliency. To achieve this goal, we recommend a three-pronged strategy.
- Using more effectively digital tools to improve operations such as employing machine learning (ML) to improve risk management, trade analytics etc.
- Creating structures for crisis management and doubling down on advanced technologies, such as virtual reality (VR) and artificial intelligence (AI).
- Embracing new ways of working virtually to gear up for whatever the future brings.
Across the value chain, the pandemic exposed fault lines that led to failures in coordination, safety and customer engagement. A lack of resiliency is compelling commodities companies to prioritize business viability over short-term economic gains. Evolving regulatory pressure and cyber risks have added pressure to companies’ day-to-day operations.
This has forced many businesses to embrace remote work as most business interactions and transactions went fully online amid pandemic concerns. Running operations with employees working remotely made seamless communication and collaboration difficult — and hampered the pace of decision-making.
The massive shift to remote work, moreover, has opened cyber threats for companies. As a result, data privacy and compliance emerged as key issues for players up and down the commodities value chain. Remote work settings could also breed insider trading risks since many of these vulnerabilities have yet to be addressed.
Impacts across the value chain
Falling demand and prices, disrupted supply chains and remote work shifts are creating operational havoc. For example:
- Increased market volatility accompanied by a drying up of liquidity. A cloud of uncertainty is preventing commodity traders from taking long-term positions. Under pressure to contain risks, companies are compelled to increasingly use options (a standard derivative instrument to hedge against risk), which has set off a spike in operating costs felt from increasing premium expense.
- Increased erosion of creditworthiness of counterparties to the commodities trade has set off new risk management challenges. The disruption’s impact on cash flow is leading to a capital crunch, which increases the potential consequences of liquidity risk.
- Business shutdowns, geographical lockdowns and the financial woes of all parties have created supply chain management challenges across the commodities value chain. Existing systems are not equipped to provide the level of operational visibility at secondary and tertiary suppliers across the value network, which limits proper assessment of risks. Inflexible logistics networks are proving to be an impediment to move commodities in a profitable manner amid rising costs of tankers, terminals and warehouses. Further, shipping is suffering delays, insurance and other costs.
- A working capital crunch and credit rating downgrades is creating back-office challenges. Receivables and cash flows are severely affected by financial difficulties of counterparties to trade. Global trade is predicated on a legal system that relies only on delivery and acceptance of physical trade documents. Restrictions on movement is therefore dealing the industry a tragic blow. Accounting systems are challenged to accommodate unprecedented occurrences such as temporary negative prices for oil derivatives. Scenarios such as fair values sinking below net realizable values are not what these accounting systems were built to accommodate (as what occurred when oil future prices plunged into negative territory).
Despite these challenges, commodities trading organizations can sustain and create new growth avenues by leveraging advanced technology, improved crisis management strategies and embracing new ways of working. To navigate the current crisis — and beyond — we suggest the following:
1 Employ digital tools and appropriate responses to address challenges in operations.
To cope with pandemic-induced market volatility, commodity companies would do well to drive realistic valuation and informed market risk management via a thorough review of market liquidity and independent price verifications and determining forward curve values. As demand across all commodities improves throughout the second half of 2020, players should remain cautious and prepare for volatility as liquidity-induced recovery might not prove sustainable until organizations start showing recovery in their earnings backed by growth. However, the upcoming U.S. presidential elections in and rising U.S./China trade tensions could exacerbate ongoing economic uncertainty.
Challenges to trading systems posed by remote working can be effectively addressed by embracing trade analytics powered by ML algorithms. Such algorithms can detect anomalies and help traders to have an accurate read of the markets and optimize strategies to manage market shifts. Stress-testing scenarios may be made comprehensive by using market data collected during this pandemic to strengthen trading strategies, workflows and pricing engines.
- Risk management operations may be strengthened by making use of machine learning in credit scoring and credit risk monitoring. The robustness of the process may be enhanced by building early warning signal using different indicators. (To learn how a rule- based early warning system framework can identify borrowers at risk of distress or default read our white paper, “Safeguarding Bank Assets with an Early Warning System.”) AI/ML may also be leveraged to aid programs that involve funding calculations and cash flow analysis in various stressed situations. Armed with the new market data available from pandemic-driven crisis scenarios, companies can recalibrate their stress-testing models. All these should pave the way for implementation of robust integrated risk management platforms that are capable of tracking data across trade life cycle — pricing, trade finance, credit exposure for liquidity risk management (LRM).
Supply chain processes may be made more resilient by building risk assessment views with data from facilities, systems and direct suppliers, aided by digital twin technology. Further, predictive analytics may be developed to improve situational assessment and risk mitigation. There is also a need to invest in integration of operational systems. As machines, systems and data get intelligently interconnected, companies can identify what to do and when best to do it, creating flexible, responsive, predictive operations that deliver value. Digital twin technology helps generate increased value from a product, process, facility or asset by designing, implementing and maintaining virtual models of physical things, replicating their features, processes and behaviors. We have an offering that allows organizations to optimize their inventory operations by leveraging all sources of data (both internal and external) to address demand volatility, supply variability and predict backorders. It improves cash flow and reduces inventory costs and in client engagements is over 90% accurate in predicting back order quantity. Overall, it enhances inventory optimization by 20% and significantly minimizes risk associated with excess stock. Increasing digitization in shipping operations offers improved accuracy in data capture, cost and route optimization, improved customer experience and efficient management of the shipping value chain, including bunkers supply. Commodity trading companies need to invest in IoT, analytics and AI to enable their shipping operations to overcome prolonged operational challenges.
- Back-office operations can be vastly improved through accelerating digitization using AI. For example, AI can help companies to maximize working capital utilization and optimize vendor payment terms without harming the vendor relationship. (To learn more, read “AI Operations Intelligence: Creating Intelligent Business Processes with AI.”) Transitioning to straight through processing (STP)-based accounting system can enhance efficiency by automating hitherto manual accounting transactions such as the accrual of interest on loans by linking it to upstream modules. Commodities companies should consider building intelligent receivables management platforms similar to products such as HighRadius.™
Adopting distributed ledger technologies, blockchain-based trade finance solutions can drive enhanced trust and business continuity through electronic documentation.
2 Create structures for crisis management and leverage advanced technologies to achieve resilience.
By leveraging virtual reality technology, companies can create 24x7 connected virtual command centers to strengthen their 360-degree ecosystem views that aid in real-time decision-making. On the people front, companies have to identify critical incident management roles and their specialized training needs considering physical and virtual operating environments. Business continuity procedures (BCP) need to be enhanced to deal with events like mass sick leaves, travel restrictions and large-scale remote work shifts. To further strengthen structured approaches to crisis management, data points gathered during the pandemic can be used by companies to enhance stress testing scenarios of the business model and to improvise their crisis management playbook that can make them more resilient for future crises, if they occur.
On the technology front, initiatives to build resilience should begin by leveraging new data points and rebuild technology models to steer operational decisions. For example, companies usually have visibility of their direct suppliers but none whatsoever for the next level suppliers which are used by this primary supplier. Companies can build new multi-tier dashboards, which give them better access and control over their supplier network. Further, web enablement of core applications, mobile adoption for core processes and cloud strategy for key applications would go a long way in paving the way for resilience. Digital twin technology can be deployed to create digital portrait of the end-to-end supply chain to explore dynamic sourcing options, assess risks, enable real time monitoring and improve process efficiencies.
3 Embrace new ways of working.
The shift to remote work is unleashing the phenomenon we term Remotopia, compelling organizations to play catchup in a new business reality. Companies need to ramp up infrastructure by leveraging infrastructure as a service (IaaS) and software as a service (SaaS) models for ensuring seamless bandwidth for critical systems. Transition to the new paradigm should also be accompanied by new people measures designed to reflect the changed work environment of Remotopia. These include ensuring transparency in working hours, better work-life balance and revised policies for medical, appraisals and leaves.
Management also needs to ensure that teams thrive (rather than merely survive) in the new environment. In order to enhance employee skill sets, companies need to create competency development programs in the areas of their work/interest. Also, companies need to explore advanced digital technologies for enabling bigger events such as town halls, exhibitions, congresses, etc., to boost collaboration among employees.
Increased risk of fraud must be dealt with by reinventing operational processes with a healthy dose of awareness. Companies should assess privacy and mitigate insider fraud risk on roles and processes under remote work to better target newly emerging insider/personally identifiable information (PII) risk. Policies and procedures may be realigned to accommodate COVID impacts (e.g., data access/security considerations for remote work, new threat investigation policies, insider trading). Such processes may be further aided by masking data to protect confidential information while loading it into non-production environments.
The Pandemic’s Fallout
The global pandemic has unleashed unprecedented disruption across all segments of the commodities markets — oil and natural gas, mining and metals — adversely affecting demand and creating price volatility.
For the first time, oil markets experienced negative derivative prices and a huge fall in demand is on the cards for 2020. Commodity prices are forecast to fall by 10% to 15% in 2020. Meanwhile the mining industry is expected to lose around $200 billion in its 2020 earnings, and 419 oil and gas companies have filed for bankruptcy in the U.S. Across the commodities spectrum, suspension of production and operations, job cuts, huge loss in incomes and bankruptcies are being witnessed.