During the 2008–09 crisis prices of almost all commodities fall unprecedently. This resulted in the failure of many contracts. Liquidated damages are since on actual losses and not on notional losses, the same also could not be recovered by the injured party.
Prices of many commodities are fairly available on exchanges and publication Many commodities are traded in future or spot exchanges. Some of the commodities like coal, bunker fuel have an index. Prices of Crude palm is published regularly by the Malaysian Palm Oil Council (MPOC). The buyer is always aware of the international price before entering any contract. Say I want to buy coal from Indonesia then, I already have coal prices of New Castle, Argus, and Platts publications in my hand before the negotiation.
Often prices quoted by the supplier are compared with the index prices to have a fair idea of prices. Say, the supplier is offering a discount of USD 2 over-index price or the supplier is asking USD 7 above index prices. In case of long term contracts or contracts where supplies are expected to be distributed over long period, it is suggested to have “variable price” in place of fixed price in the contract.
Case Situation: A Thermal Power Plant needs steam coal at the rate of 50,000 MT per month for the next year. 50,000 MT is approx one vessel per month. In case a single contract with a fixed price is signed between buyer and seller and there is movement in price, either supplier or Buyer, one of the two will be at loss. A possible solution could be to re — negotiate the price at the end of every month and sign a separate contract for each vessel monthly. The second option is feasible and can save buyers and sellers from possible fluctuation in prices. However, there would be always uncertainty associated with supplies. Suppose in a month, the contract could not be finalized due to non-agreement of prices and another supplier quotes below the price offer made by the established supplier. Supplier and buyer both in this case have risk. Supplier in the absence of firm order would not source and keep material ready for shipment and buyer in the absence of firm supplier is at the risk of production loss at the thermal power plant.
The possible solution to the problem was developed by the Indian Thermal Power Plant procurement department in 2008–09, the price of steam coal was linked to the index price. For import from Indonesia, Argus Indonesian Index is adopted as a basis and for import from other countries, a combination of two to three indices is taken. For example for 5800 KCal coal, the index adopted by some thermal power plant is 50:25:25 of three indices Richard Bay API4 for 6000 Kcal/Kg NCV, Newcastle Export Index (NEX) for 6700 Kcal/Kg GAD and Global Coal New Castle (GCNEW C) for 6000 Kcal/Kg NCV.
A synthetic index is created by blending all the three indices and FOB price offered by the supplier is compared to this synthetic index. Say the price is at a premium of 2% to this index and the same is finalized for a contract of one year. The FOB price shall also fluctuate and shall always remain at 2% premium of this synthetic index. The payment is made by calculating the synthetic index rate on the date of Bill of Lading based on the three weekly publications.
Why three indices ?
During 2008–09, the Indonesian coal index was at a nascent stage. The market in Australia and Africa were more organized. However, the coal sought by the power plant was of different specification and was normally sourced from Indonesia only. These three indexes were selected because they have developed market, robust data reporting, and the oldest. The three were mixed in different ratios to arrive at a synthetic index so that the index price is comparable with the Indonesian coal price.
For more on International Trade : Guide to Import Export for Beginners
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