Introducing Risk Reporting in SAP Agricultural Contract Management

Risk reporting plays a pivotal role in the soft commodities market for several critical reasons:

Market Volatility: The soft commodities market is highly susceptible to price fluctuations influenced by various factors, such as weather conditions, geopolitical events, and supply and demand dynamics. Risk reporting helps market participants to track and analyze these fluctuations, enabling informed decision-making.

Price Risk Mitigation: Soft commodity producers, traders, and consumers need to manage the risk associated with price volatility. Effective risk reporting allows them to monitor price movements, assess potential impacts on their portfolios, and implement hedging strategies to mitigate adverse price changes.

Operational Risks: The soft commodities supply chain involves multiple stages, from production and storage, to transportation and processing. Operational risks, such as quality deterioration during storage, logistical disruptions, or regulatory changes, can affect the quality and quantity of commodities. Risk reporting helps identify and address these operational risks.

Financial Risk Management: Participants in the soft commodities market often deal with large sums of money. Effective risk reporting aids in managing financial risks associated with credit, liquidity, and cash flow, ensuring that companies can meet their financial obligations and optimize their capital allocation.

Compliance and Regulatory Requirements: The soft commodities market is subject to various regulations and compliance standards. Risk reporting helps market participants stay compliant with reporting requirements, reducing the risk of legal and regulatory penalties.

Strategic Decision-Making: Risk reports provide valuable insights into market trends and potential risks and opportunities. Market participants can use this information to make strategic decisions, such as when to enter or exit markets, allocate resources, or adjust their trading strategies.

Supply Chain Management: Effective risk reporting helps companies manage risks throughout the supply chain, from sourcing raw materials to delivering finished products. This includes tracking inventory levels, assessing the quality of stored commodities, and ensuring timely and efficient transportation.

Counterparty Risk: Soft commodities trading often involves multiple parties, including suppliers, buyers, and financial institutions. Risk reporting helps assess the creditworthiness of counterparties, reducing the risk of financial losses due to defaults.

Scenario Analysis: Risk reporting allows market participants to conduct scenario analyses to understand how various events, such as extreme weather conditions or geopolitical tensions, could impact their operations and financial positions. This helps in devising contingency plans.

Investor Confidence: For companies involved in the soft commodities market, providing transparent and accurate risk reports can enhance investor confidence. Investors, including shareholders and lenders, often rely on risk reports to evaluate a company's risk exposure and risk management strategies.

Broadly speaking, in agriculture, risk is categorized into five primary domains, although it's worth noting that the exact categorization may vary by region and company.

1. Production Risk: This category encompasses risks associated with the actual production process. For farmers, this could entail yield-related risks heavily influenced by external factors like weather conditions. It also extends to concerns about livestock, such as diseases affecting cattle.
2. Financial Risk: Farmers often grapple with significant financial obligations. They must make substantial upfront investments in equipment, seeds, fertilizers, and more. However, they only receive payment upon delivering their crops, leading to financial uncertainty. Securing these necessary funds can be complex and region-specific.
3. Institutional or Legal Risk: This category deals with risks stemming from government actions, regulations, laws, and policy changes. Governments frequently introduce modifications, like restrictions on chemical usage, impacting agricultural practices and costs.
4. Human Risk: Like any business, farming operations often involve multiple individuals, be it family members or hired workers. The inherent risk here is that any human can fall ill or experience accidents, potentially disrupting workflow.
5. Price or Market Risk: This risk pertains to the ever-changing prices and market conditions in agriculture. Farmers aim to sell at the highest possible prices, while buyers seek to purchase at the lowest rates. Market fluctuations, even minor ones, can significantly impact profits, especially for large trading companies dealing in substantial quantities.

SAP Agricultural Contract Management primarily focuses on managing price or market risk. It equips users with tools and integration capabilities to gain a comprehensive view of market risks, allowing them to respond effectively to market fluctuations.

Let's identify the various types of reports we have within our risk reporting framework. Within the category of position reporting, we offer multiple distinct reports. Currently, in our standard offering, we provide three key reports. Each of these reports also has multiple versions, which we'll discuss shortly. But for now, let's focus on the reports themselves:

Price Type Report

Provides an overview of the total quantity per price status over all selected contracts.

This report focuses on the price components. Within any soft commodity contract, you have different price elements, such as fixed prices, futures prices, and basis prices. For instance, if you have a contract with 1,000 bushels, you may have 400 bushels at a fixed price, 200 bushels at a futures price, and 400 bushels at a basis price. The price type report dissects these components, showing how much quantity falls under each pricing category.

Premium Report

Reports on the basis (= premium) quantity at risk, which is defined as quantity for which the basis price has been fixed.

Sometimes referred to as the basis report, this one concentrates solely on basis prices. Basis prices are the difference between local and futures prices. The premium report reveals the risk associated with these basis prices.

Slate Report

Reports on the future quantity at risk, which is defined as quantity for which the future price has been fixed. The slate report also includes the offsets coming from the derivative (= future) contracts.

The slate report focuses on futures components, which include hedges. We'll delve into hedges in more detail shortly. The slate report exclusively looks at the futures aspects of your position.

Additionally, we have the Net Position Report, which amalgamates elements from all three reports. This report is particularly useful for companies structured differently, where traders handle both basis and futures components.

These distinctions arise because larger trading companies often have specialized teams dedicated to basis and futures management. However, smaller firms may prefer a combined view. The choice of which report to use largely depends on the company's organizational structure.

Each of these report types has three versions: current, end-of-day, and day-over-day. The current version presents all the data posted to date. The end-of-day version focuses on the information available up to a specific cutoff time, suitable for morning checks or month-end closing processes. Lastly, the day-over-day version reveals changes between two timestamps, crucial for understanding what transpired between specific periods, like month-end reconciliations.

These different report versions cater to distinct business needs and contexts, providing flexibility and precision in managing soft commodity positions.

Now, let's take a closer look at each of these report versions and their specific applications:

Current Version

This version provides a comprehensive overview of all position data available up to the present moment. It includes all transactions and relevant information up to the current timestamp. The current version is beneficial when you need a real-time snapshot of your positions, without any cutoff restrictions. It's especially useful when you want to see the entirety of your positions at any given time.

End-of-Day Version

The end-of-day version narrows its focus to the position data up until a specific cutoff time, typically aligned with market close or other critical time markers. It's like freezing your position status at a chosen time of day. This version is valuable for daily checks, risk assessments, or processes like end-of-month closings. It allows traders to review how their positions stood at the close of business, enabling them to make informed decisions for the next trading day.

Day-Over-Day Version

The day-over-day version serves a unique purpose. It highlights the changes and differences in your positions between two specific timestamps. For instance, it can show you what has occurred between the end of one trading day and the start of the next. This version is essential for tracking alterations in your positions over time, providing insights into the evolution of your risk exposure. It's particularly useful for month-end reconciliations or analyzing position adjustments.

In summary, these various report versions cater to different operational needs and scenarios within the soft commodities market. Whether you require a real-time overview, a snapshot at a specific daily cutoff, or insights into position changes over time, these versions ensure that you have the right information to manage your positions effectively. The choice of version depends on your specific business processes and objectives, providing flexibility and precision in position reporting and risk management.

The price type reports on three key figures are reported for each of the supported pricing statuses (NPE, NFI, and NBE).

This report provides a view on the price status with focus on basis/premium/location differential. The premium report is only evaluating the basis component of those price fixations where the basis is fixed.

A slate report in the agricultural commodity space is a document that provides a comprehensive overview of futures positions held by a trader or company for a specific commodity. It typically includes details such as the quantity of futures contracts, expiration dates, and associated market prices. Slate reports are essential for tracking and managing risk exposure, optimizing trading strategies, and making informed decisions based on market trends and movements. They serve as valuable tools for traders, analysts, and risk managers to monitor and assess their portfolio's performance and market position in real-time. In ACM the Slate report provides a view on the commodity position including physical contracts and derivative hedges.

A mark-to-market report in the agricultural commodity space is a financial assessment that reflects the current market value of a trader's or company's positions in commodity contracts. This report calculates the value of open positions based on prevailing market prices, allowing traders and companies to accurately measure their profit or loss in real-time. Mark-to-market reports are essential for assessing the financial health of commodity trading portfolios, monitoring risk exposure, and making informed decisions about trading strategies. They provide valuable insights into the performance of commodity investments, help traders manage their positions effectively, and enable timely adjustments to trading strategies based on market conditions. Mark-to-market reports are often used by traders, risk managers, and financial analysts to evaluate the profitability and risk of commodity trading activities.

Each contract item might have multiple price fixation. Only flat or partially priced (NFE, NBE) fixations are MtM relevant. The relevant market exchange and period is defined for each price fixation.

Market prices itself are not stored with each contract, but evaluated at time of report execution. The contracts hold the reference to the market data (DCS, MIC, Key Date / Contract Maturity Code). References are stored in the market condition types; see also orthodoxy for future period determination.

Orthodoxy will change as per company decision, after the future period is not liquid anymore

• New reference future period needs to be maintained in the orthodoxy table
• Transaction for contract re-evaluation (CMM_LREV) needs to be executed. Transaction will update the contract maturity code of the market conditions in each of the selected contracts to the new maturity

The orthodoxy defines which future period will be leveraged for the market comparison.

Adjusting Incoterms to a Market Reference Point.

Basis market data may not be available for all the end-user's locations which are represented by the incoterms. The cost difference between the actual location and the location of the market norm is called a basis adjustment.

The basis adjustment is a manual price condition that adjusts the contract basis price to the location of the market basis. Basis adjustments are captured in the contract as non-CPE condition types and mapped accordingly as an adjustment

A spread value adjusting the contractual values to the market reference of the market value can additionally beincluded when calculating MTM separately for different 'groups' (for example futures vs. premium/basis). A spread is caused when the contractual fixed prices are deviating from the market norm.

• The futures price reference consists of the following components:
• Derivative contract specification, for example, Soybean Futures
• Market identifier code, for example, Chicago Board of Trade
• Contract maturity code, for example, K (May)
• Price type, for example, Closing
• A spread applies if the fixed contract reference does not match market reference

Time Spread

Occurs when the future period (= contract maturity code) of contract price fixation and market reference do not match.

Cross-Market Spread

All other spreads.

Multiple different currencies might be involved in the same MtM calculation

• Market currency → currency in which the market is traded (i.e. USD for CBOT)
• Document currency → currency in which the contract is created
• Statistical currency → currency in which MtM is reported

The statistical currency is defined in the Commodity Management customizing area.

Important Components: Currency Conversions

Conversion from Market to Document currency is leveraging the FX rates defined in the contract price fixation itself

Conversion from Document to statistical currency is leveraging the standard FX rates defined in the SAP currency conversion tables (table TCURR)

Conversion from Market to Document currency is leveraging the FX rates defined in the contract price fixation itself.

Conversion from Document to statistical currency is leveraging the standard FX rates defined in the SAP currency conversion tables (table TCURR).

There are three variants for the MtM reports in ACM.

In the context of agricultural commodity trading, the mark-to-market components for valuations of stock refer to the factors or elements considered when assessing the current market value of inventory or stock holdings. These components include:

1. Market Prices: The prevailing market prices of the commodities held in stock are a primary factor in determining their value. Market prices fluctuate based on supply and demand dynamics, seasonal factors, geopolitical events, and other market drivers.
2. Quantity: The quantity of each commodity held in stock is a crucial component of valuation. Larger quantities generally contribute to higher valuations, assuming market prices remain stable or increase.
3. Quality: The quality of the commodities in stock can significantly impact their market value. Higher-quality commodities typically command higher prices, while lower-quality or damaged goods may be discounted.
4. Storage Costs: The costs associated with storing and managing the inventory, including warehousing, handling, and insurance expenses, are considered in the valuation process. These costs can vary based on factors such as location, storage facilities, and contractual arrangements.
5. Transport Costs: Transportation costs incurred in moving commodities to and from storage facilities are also factored into the valuation. These costs depend on the distance traveled, mode of transportation (for example truck, rail, barge), and prevailing freight rates.
6. Market Conditions: Current market conditions, including supply and demand trends, market sentiment, and price volatility, influence the valuation of stock. Changes in market conditions can impact the perceived value of inventory holdings.

Mark-to-Market
Contract Value		Market Value
Standard Price per Base UoM Moving Average Material Ledger		Future (per contained Commodity Qty) Market Point Basis Index
	bucketed by
	Stock On Hand Unrealized Goods Receipts Unrealized Goods Issues

By considering these mark-to-market components, traders, businesses, and investors can accurately assess the value of their commodity stock holdings in line with prevailing market conditions. This information enables informed decision-making regarding inventory management, risk mitigation, and trading strategies in the agricultural commodity market.

• The Contractual Value is calculated using the Material Valuation.
• The Standard Price is supported out-of-the box and is versioned (per material, plant, batch [if batch-managed]).
• Other valuation types are only supported by an Add-In to be implemented as per the requirements

A Market Value is calculated using conditions in a 'Market Price Procedure', for example with following conditions:

• Prices as defined by market indexes, for example a Future Derivative
• Deductions or surcharges that reflect quality or location-related aspects
• Total Value is Market Value + P/D Value.
• Market Value (Net Quantity * Market Price) is adjusted with the Premium / Discount value to derive the Net Value.
• Premium Discount value is defined as effective value derived based on applying DPQS value schedule to the characteristics.
• Sequence is to first identify the adjusted values corresponding the individual characteristic values derived based on the value schedule applied to the characteristics.
• The P/D value, which is derived as sum of all individual adjusted values, will be divided by the Net quantity to determine the P/D rate.
• The P/D value will be added to the Market value only for the Basis records of the Stock MtM lines.
• The characteristic values will be displayed in the Stock MtM so that the user can validate the P/D value by utilizing the DPQS Value schedule simulation feature. See attached excel for the current report layout.

It is possible to derive the net value adjustment based on both Gross and Net quantities.

This is specified in the DPQS master data.

1. Gross quantity → Gross Physical Inventory or Gross Quantity of the Movement. LAQ → Net Physical Inventory or Net Quantity of the Movement.
   
2. Adjustment rates are defined per characteristic.