A commodity is a basic ingredient, a building block used in the production of other goods and services. There's wheat and cotton and pork bellies. Gold, silver, and copper are a few of the metals traded as commodities. Oil and natural gas are in the energy category. Commodities are interchangeable in terms of quantity and quality: A barrel of oil is a barrel of oil; a bushel of wheat from Kansas is the same as a bushel of wheat from Montana. (Although no one buys or sells anything as paltry as a bushel.) Standards of quality and quantity are ensured via rules set by the federal government and the individual commodities trading exchanges -- such as the Chicago Board of Trade and the New York Mercantile Exchange.
Water is a commodity in the traditional sense of the word, but is not traded on commodities exchanges ... yet.
Trading in commodities is not for the inexperienced or investors with a low tolerance for risk. Commodities can be traded in spot markets, but are more commonly traded as futures. The spot market is a cash-and-carry sort of operation. The futures market involves trading contracts that specify the date for delivery of a certain amount of a commodity and the price that will be paid. Someone who has no use for 15,000 bushels of wheat could still be a player trying to make money by buying and selling wheat futures at opportune times as others try to lock in good prices.
Commodity moves have a typical pattern: Demand for, say, corn rises, as ethanol becomes popular. Farmers plant more and more. Then there's an oversupply. So the plantings decrease, and there could be a shortage.
In the chemical industry, it is common to distingush between commodity products and specialty chemicals. Specialties are products that are customized to the needs of the customer. Commodities are those that are made to industry specifications. Often commodities are produced in large, highly automated plants. That keeps costs down, but competitive pressures also keep margins lower.
Specialties are usually developed by working closely with a customer to find a product that meets his particular needs or solves a problem. A good example is 3Ms development of masking tape for use in autopainting in the era of two-tone paint styling. The product had to be adapted to exactly meet customer needs. And as a reward, 3M got the lions share of the business. But in time, others learned to make competitive products. As this happens, specialties become commodities and margins fall. Hence, chemical companies must constantly reinvent themselves to maintain their margins.
Because commodities are made to industry specifications, the industry experiences efficiencies. Competitors often swap product to save shipping costs. Hence, your order placed with a distant supplier with a nice salesman may be filled by the closest supplier. Similarly, product is often comingled in distribution. Ammonia comes up to the midwest in a pipeline fed by numerous producers on the Gulf coast. Gasoline and diesel fuel work similarly. Methanol comes up by barge and is stored in terminals in large tanks. All suppliers in the region sell out of the same tank.
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