How physical arbitrage works
Global commodity traders seek to identify and respond to supply and demand differentials between linked markets. They use arbitrage to trade physical commodities without incurring price risk. They hedge price exposure using exchange-traded contracts and over-the-counter instruments.
An offtake agreement with a Peruvian mine
Prior to this transaction, Trafigura had arranged to source copper concentrates via an offtake agreement with a Peruvian mine.
SUPPLY AGREEMENT WITH FINISH COPPER SMELTER
It had also agreed to deliver copper concentrates to a Finnish smelter.
Trafigura subsequently identifies a geographic arbitrage opportunity. It switches its supply source for the Finnish smelter and finds a different buyer for the Peruvian concentrates.
BUY CONCENTRATES FROM SPANISH COPPER MINE
Next, Trafigura sources concentrates for the Finnish market at a Spanish mine.
SELL CONCENTRATES TO US SMELTER
It delivers the Peruvian concentrates to a US smelter.
These two transactions result in much shorter delivery journeys and yield a significant reduction in overall freight costs compared with the original Peru to Finland route.
Trafigura ships concentrates to the Finnish smelter according to the originally agreed schedule, but the US smelter wants delivery in six months’ time.
With the copper market in contango, Trafigura now identifies a time arbitrage.
STORE CONCENTRATES IN IMPALA WAREHOUSE
The US smelter is prepared to pay a premium for forward delivery in six months. Trafigura hedges its price risk in the futures market and earns additional margin because it can store the Peruvian concentrate at low cost through its wholly owned subsidiary, Impala Terminals.
BLEND TO NORTH AMERICAN SPECIFICATION
The US smelter requests a particular specification for its concentrate. Trafigura can meet this requirement cost-effectively by blending the Peruvian concentrate in its warehouse to create the required grade synthetically. This technical arbitrage earns it additional margin.
Finally, the blended concentrates are shipped to the US smelter, arriving six months later as agreed. The combination of arbitrage techniques has increased Trafigura’s profitability and price competitiveness.
