Background and Rationale
Commodity markets alongside securities have grown several folds during the last two decades. There is a wide range of participants, ranging from investment banks to those who are specialists in commodity trading (Geman, 2009). One of the major reasons behind the market’s growth has been its highly volatile nature, which in essence follows the basic investment principle of high risk, high return (Chatnani, 2012). These participants enter the market with different objectives; those who look for an arbitrage opportunity to make short term gains as well as those who enter into forwards and futures contracts with the idea of hedging risks (Poitras, 2013). Talking of the commodities market, UK exchanges’ commodity market has a stable foundation of approximately £12 billion in the initial margin, which indicates the prevalence of transactions in large volumes (Marroni & Perdomo, 2013).
On the other hand, the highly regulated nature of the market poses significant challenges for investors to deal with. As the sector has grown, concurrently the authorities have looked to take steps to regulate the sector with the basic objective of enhancing competiveness (Geman, 2009). Evidence to this is the drop in headcount in commodities’ trading sector from 2,794 in 2010 to 2,176 in 2013 and a lower Value at Risk (VaRs) of leading commodities banks (Termeer, 2013).
The study shall evaluate the relative nature of the commodities’ market in the UK, in particular transactions related to oil and gas and the overall competitiveness of the sector. Moreover, the study shall incorporate strategies that are used by companies in the oil and gas sector to make commodity trading more competitive.
Research Questions
The proposed study shall address the following questions;
- What are the different methods that have been introduced in UK’s commodity markets to make it more competitive?
- Analyze the UK’s commodity market in the light of recent developments such as derivative instruments and other investor focused strategies adopted by firms operating in the market. Also, evaluate future prospects for this market in coming years.
- To what extent these strategies have increased the level of competition within the market and assess the investors’ response in this context.
Literature Review
Inkpen & Moffett (2011) write that in recent times commodity market has moved towards greater centralization with the basic objective of cost saving (Inkpen & Moffett, 2011). Since, freight costs greatly impact the pricing strategies of oil and gas in the commodity market, having centralized trading has allowed firms to materialize significant benefits. Moreover, this centralization has brought companies in the same marketplace, thereafter enhancing competition among them and also contributing towards the development of global commodity market.
Moving on, Heshelow (2010) suggests that companies have looked to adopt better management of transfer pricing risk (Heshelow, 2010). Transfer pricing risk basically relates to profit/loss allocation by multinational corporations operating in other countries by abiding by the local tax laws (Wittendorff, 2010). With better transfer pricing policies, firms have firstly ensured that all legal grounds are being complied by fully and at the same time this has been instrumental in building a strong reputation for firms in operating in the market. Since, commodity markets are highly volatile, reputation of companies proves to be a vital differentiating factor for investors.