Managing SAP Agricultural Contract Management Contract Pricing Master Data

The pricing requirements for agricultural companies are based on whether the commodity is priced through the futures market. Commodities driven by futures are called hedgeable, and include corn, wheat, soybeans, and so on. Those not driven by futures are termed non-hedgeable, and include feed wheat, soybean hull, potatoes, amber durum, and so on.

Flexibility in pricing is crucial, especially for hedgeable commodities, allowing for the breakdown of prices into multiple components. Hedgeable commodities have a futures component and one or more basis components, while non-hedgeable commodities typically require only one basis component.

Regardless of the commodity type, pricing needs flexibility in terms of when and how it is determined in contracts. In the industry, it's common to perform logistics before pricing all components, and to utilize provisional or partial pricing for invoicing. Additionally, there is a need for multiple pricing instances against the same contract line item, requiring support for multiple pricing lots.

The foreign exchange (FX) requirement introduces complexity when the contract currency differs from the futures market currency. Provisional exchange rates must be captured, and the ability to fix the exchange rate on the pricing lot is necessary based on agreements with the counterparty. Provisional invoicing based on provisional exchange rates and final invoicing based on fixed exchange rates are also needed.

To meet these requirements, the Commodity Pricing Engine (CPE) is utilized by SAP Agricultural Contract Management to price both hedgeable and non-hedgeable commodities.

Price components can be divided into two types: futures and basis.

Basis can consist of one or more primary and secondary components. Primary basis components are relevant to the futures market and include factors like location differentials. These reflect the cash price at a specific location in relation to the futures market. Secondary basis components are not related to the futures market and are based on factors such as quality or freight. They are typically internal prices not known by the counterparty.

The number of basis components that need to be defined is a company decision.

The formula for price calculation is: Price = Futures + Primary Basis + One or more Secondary Basis. This equation represents the cash price and the basis components required depend on the company's decision. Some companies may use only one primary basis without further breakdown. Secondary basis components are utilized to reflect transportation costs, quality considerations, or other factors important for managing the business. However, the specific details of the secondary basis components are not communicated to the counterparty, as they are primarily internal management components.

The secondary basis can include expenses, quality spreads, transportation costs, or other internal costs or overheads. In Brazil, for example, multiple secondary basis components may be used to cover transportation between different ports. These components are not necessarily paid to the grower but are important for pricing and margin calculations. They may also include statistical basis prices that don't directly impact payment or mark-to-market assessments.

In summary, basis components in pricing can vary based on location differentials, quality, freight, and other factors. Primary basis components are related to the futures market, while secondary basis components are internal and not disclosed to the counterparty. They serve various management purposes, such as managing costs, calculating margins, or supporting internal pricing strategies.

In review, basis refers to the difference between the cash price of a commodity in the local market and the price of the corresponding futures contract. It represents the local supply and demand factors that influence the price of the commodity at a specific location.

The basis is an important component in pricing agricultural commodities because it accounts for factors such as transportation costs, storage costs, quality differentials, local market conditions, and regional supply and demand dynamics. It reflects the unique characteristics and conditions of a particular market or location.

Traders and farmers use basis as a reference point to determine the final price of the commodity in the contract. By adding or subtracting the basis from the futures price, they can calculate the cash price at which the commodity will be bought or sold at the specified delivery location.

The basis can fluctuate over time due to various factors, including changes in supply and demand, weather conditions, transportation costs, government policies, and market speculation. Understanding and monitoring the basis is crucial for effectively managing agricultural contracts and mitigating price risk.

Futures markets in the agricultural industry are financial exchanges where standardized contracts for the future delivery of agricultural commodities are bought and sold. These markets allow participants, such as farmers, processors, traders, and speculators, to manage price risks associated with agricultural commodities.

In a futures market, contracts are created that specify the quantity, quality, and delivery date of the agricultural commodity. The prices of these contracts are determined through open and competitive trading. Participants can take either long positions (committing to buy the commodity in the future) or short positions (committing to sell the commodity in the future).

Futures markets provide several benefits for participants in the agricultural industry. They allow farmers to lock in prices for their crops before harvest, providing price stability and risk mitigation. Processors and manufacturers can secure a consistent supply of raw materials at predetermined prices. Traders and speculators use futures markets to profit from price fluctuations without physically owning the underlying commodities.

These markets also serve as a platform for price discovery, where supply and demand factors are reflected in the trading prices. They provide transparency and liquidity, allowing participants to buy or sell contracts at any time before the contract's expiration.

Derivative contract specifications refer to the detailed terms and conditions that define the characteristics of a specific derivative contract. These specifications are standardized and established by the exchange or market where the derivative is traded. Here are the key components typically included in derivative contract specifications:

1. Underlying Asset: The underlying asset is the financial instrument, commodity, index, or other variables on which the derivative contract's value is based. For example, in agricultural derivatives, the underlying asset could be a specific crop, livestock, or commodity index.
2. Contract Size: The contract size, also known as the lot size, represents the quantity or units of the underlying asset that each derivative contract represents. It provides a standardized unit for pricing and trading the derivative. For agricultural derivatives, the contract size may be specified in terms of weight, volume, or other appropriate measures.
3. Contract Expiration: The contract expiration, also called the maturity date, is the date when the derivative contract ceases to exist. It indicates the last day on which the contract can be exercised or traded. Different expiration months or cycles may be available for trading, allowing market participants to choose contracts that align with their specific needs.
4. Price Quotation: The price quotation specifies the unit of price measurement for the derivative contract. It defines how the contract's value is quoted and calculated. For agricultural derivatives, prices can be quoted in various ways, such as dollars per unit, cents per pound, or bushels per contract.
5. Tick Size: The tick size represents the minimum price increment at which the derivative contract can trade. It determines the smallest price movement allowed for the contract. The tick size is essential for price discovery and setting limits on price fluctuations.
6. Delivery/Settlement Terms: For certain types of derivatives, such as futures contracts, the contract specifications may outline the delivery or settlement terms. These terms describe how the physical delivery or cash settlement will occur upon contract expiration. For agricultural derivatives, delivery terms may include specific location requirements, grading standards, or alternative cash settlement methods.
7. Trading Hours: The trading hours specify the period during which the derivative contract can be actively traded on the exchange. It indicates the time window when market participants can submit orders, execute trades, and manage their positions.

Derivative contract specifications ensure consistency, transparency, and standardization in the trading of derivatives. By providing clear rules and guidelines, they enable efficient price discovery, facilitate liquidity, and promote fair and orderly markets. Market participants can rely on these specifications to understand the terms of the contracts they trade and to effectively manage their risk exposure.

Example of a DCS: KC HRW Wheat Futures Contract Specs - CME Group

Material Master

Stores the materials used in SAP Agricultural Contract Management contracts.

Physical Commodity

Details of the commodity specified in the contract.

Valuation Point

A unique market location for which a unique market norm can be defined in market curve for a set of products and/or physical locations.

Derivative Contract Specification (DCS)

Defined from the futures market contract specifications.

DCS configuration is not limited to U.S companies. The configuration depends on the specific requirements of the customer and their business relationships. Different countries may trade on various futures markets, such as Brazil trading on U.S futures markets or using European markets, such as MATIF in Paris or London.

For a good example of the types of data that go into a DCS table, see: KC HRW Wheat Futures Contract Specs - CME Group.

Basis ID

For basis valuations or differences occurring frequently, agricultural companies define basis IDs. Basis IDs capture typical or normal values in tables (by commodity, location, delivery period) and use them for mark-to-market and P&L analysis, specifically on the basis.

Market Identifier Code (MIC)

MIC represents the exchange or market where the futures contract is traded. For example, the MIC for the Kansas City Board of Trade is set up for hard red winter wheat. The MIC and DCS are linked through the configuration process.

Orthodoxy

A hard-wired, custom-defined table that can be used to define market norms (maturity key dates of a certain index) per country or profit center combination and delivery period (typically a calendar month).

DCS is a crucial aspect of setting up futures contracts. To configure DCS for each futures market, you need to establish certain parameters. These parameters include:

1. Physical Commodity Setup: You have to define the physical commodity associated with the futures contract. This involves specifying details such as the product symbol (obtained from the CME website), commodity type (for example, hard red winter wheat), default unit of measure (for example, bushels), and delivery periods with their respective start and end dates.
2. Market Identifier Code (MIC) Configuration: MIC represents the exchange or market where the futures contract is traded. For example, the MIC for the Kansas City Board of Trade is set up for hard red winter wheat. The MIC and DCS are linked through the configuration process.

Example of a derivative details screen which provides the contract size, validity date, the quotation units, and the tick value.

In addition to the previous steps, you need to specify the periods and their corresponding start and end dates. This information is typically available on the website related to the futures market you're working with. These periods are crucial in determining the delivery features and date cut-offs, commonly referred to as key maturity dates. For example, you may have key maturity dates for March, May, July, September, and December. However, these dates may vary depending on the specific futures market and the commodity being traded.

The pricing table is where you enter futures prices for the specific futures contract. The table includes fields for the DCS, MIC, commodity, date, key maturity date, and quotation prices. These prices are typically entered manually into the internal systems, as the company may not have an automatic service to load them.

Decimal places for prices and the currency in which the settlement occurs are determined based on the specifications provided in the DCS. This information is obtained from the respective futures market, such as CME.

The pricing table serves as a real-time interface between SAP (the company's system) and the market data from the futures market. The market prices can be retrieved through a market data interface, depending on the company's subscription or service.

In SAP Agricultural Contract Management, there is a need to create a basis ID to enter the actual basis prices. The basis ID is determined by the company based on their specific factors, such as location differences in prices. For example, in our internal system, we use the basis ID to represent the destination plant location and the corresponding commodity. This allows for different prices based on the specific combination of destination and origin. However, the definition of the basis ID is a decision that varies from company to company. The price entry is then entered using the basis ID as a reference.

Based on the DCS and key maturity date, the primary basis component is configured under a specific category. In this example, we are focusing on the primary basis. There are also categories for secondary basis, such as transportation, quality, and non-hedgeable. The configuration defines whether the basis represents a provisional price or a futures price. The basis ID, DCS, and MIC are entered, along with the date for which the price is being entered. The type is specified as purchase or sale. The date range is defined, such as the month of March. In this example, the price is represented as $1, mapped against a maturity date in May. The two prices, provisional and market, serve different purposes which will be explained later. The primary basis is used for mark-to-market and P&L reports.

Secondary basis prices can be entered under the basis category 200 (configured for transportation related) and 300 (configured for quality related). These configurations are made as per SAP Agricultural Contract Management business configuration sets.

Non-hedgeable prices are treated as a basis component and configured under category 400 (configured as per SAP Agricultural Contract Management business configuration sets) in FDCS17B. Similar to other basis components, you can enter provisional prices and market prices.

A valuation point refers to a specific combination of factors or variables that are used to determine the pricing approach for individual line items in a commodity contract. It represents a key element in the pricing determination process.

A valuation point typically includes criteria such as location differentials, delivery points, title transfers, or other relevant factors that impact the pricing of commodities. It serves as a reference point for pricing calculations and allows for differentiation in pricing based on specific conditions or parameters.

For example, a valuation point could represent the plant location for delivery and the specific commodity being traded. By defining the valuation point as the destination plant and the commodity, the system can automatically calculate the pricing approach based on this information.

Valuation points are essential in determining the appropriate pricing components, such as futures, basis, indexes, and ratios, for each line item in the contract. They provide the necessary context for pricing calculations and enable accurate pricing based on the specified conditions and requirements.

Valuation points are a prerequisite for pricing and contracts. They are used to determine the pricing approach for individual line items in a commodity contract. To use valuation points, they must be set up as master data in the system. The pricing approach of a contract is established through configuration and can include various combinations of futures components, basis components, indexes, and ratios. Alternatively, a flat pricing approach can also be used.

Valuation point definitions are company-specific and depend on how the company needs to price their contracts. In the provided example, the valuation point represents a location differential based on the plant for delivery and commodity. The valuation point, in this case, reflects the destination (plant) and the specific commodity. However, this is a company decision, and each customer may have different requirements for pricing differentiation.

Creating a valuation point for each combination of variables is necessary to reflect all possible combinations. It is a one-time setup, but if there are changes to the rules or additional variations, new valuation points may need to be created accordingly. It's important to work closely with the customer to understand their specific pricing needs and establish the appropriate granularity.

The pricing approach in the contract is usually determined automatically based on the valuation point and pricing condition records. It considers whether the pricing is based on the material alone or both the material and valuation point. The pricing approach includes a predefined object delivered through a BRF+ template as a starting point. While it may seem possible to add new pricing approaches, doing so would require additional configuration efforts (RIEF) and it is recommended to use the delivered ones.

It's important to note that if a commodity requires multiple pricing approaches, additional valuation points and possibly an additional basis ID may be needed to accommodate them.

The configuration of different valuation points in the pricing approach is associated with specific condition types that are mandatory for information or calculation. This setup helps determine the pricing components, including provisional pricing, futures pricing, and condition records. By integrating the master data, the pricing determination process is effectively linked together.

There are various pricing approaches available, depending on the nature of the commodity. For hedgeable commodities, different combinations of futures, primary basis, and secondary basis are utilized. Additional scenarios, such as componentized flat, adjustable flat, and non-hedgeable flat, have their specific pricing components.

Non-hedgeable Commodities use the following:

NF = Non-hedgeable Flat = Basis

Condition records play a crucial role in the pricing procedure. They are set up for different pricing approaches and determine provisional prices. These records are also used to capture market prices and market adjustments for mark-to-market and P&L reporting. Additionally, statistical condition types may be included for expense management purposes.

In the context of the pricing procedure, it is important to consider the secondary basis and how it relates to condition types and condition records. When there are multiple basis components, there are two possible configurations: either separate condition types for each basis component or a combined condition type that encompasses all the basis components.

Condition records play a crucial role in the pricing determination process and determining the pricing approach. However, it's important to note that they are not used for price fixations. Instead, they aid in establishing the appropriate pricing approach for each commodity on the contract line item.

Setting up condition records is a one-time process, and they are associated with specific materials or material valuation points. This setup is instrumental in determining the pricing approach for each commodity. If you also want to include a secondary basis, you would set up a separate condition record at the material valuation point level. This allows for more granularity in controlling the pricing approach by considering both the material and its specific valuation point.

Let's delve into the concept of the orthodoxy table, which plays a crucial role in determining the future period to be used for market comparison. This table, known as CMM_ORTH_MATURE and accessible through the SM31 transaction, is defined in our internal environment.

The orthodoxy table is particularly significant for pricing the primary basis component, as it helps determine the maturity key date. When setting up this table, you need to provide relevant details for each phase, including the controlling area and periods. These details are then linked to the corresponding future delivery periods. For instance, when pricing a contract in March, an orthodox approach would involve using the nearby future, such as May. Opting for a future period further away, like July, would be considered non-orthodox.

When you create a contract, it's crucial to consider the maturity key date. If the current date exceeds the maturity key date, you must update it to the next relevant delivery period. This update has implications for existing contracts, necessitating a contract revaluation process. Regular reviews and updates of the maturity key dates are essential to ensure accurate contract pricing.

The concept of orthodoxy refers to the practice of using the nearby future for pricing, while non-orthodox approaches involve selecting future periods further away. While most companies typically follow an orthodox approach, there are instances where non-orthodox approaches are employed. The availability of future periods depends on the specific commodity and its corresponding futures market. By consulting the orthodoxy table and considering the nearby future, you can determine the appropriate maturity key dates for contract pricing.

Furthermore, the orthodoxy table serves as a reference for determining the pricing approach and aligning it with the relevant future periods. During contract creation, the pricing components, such as provisional pricing and market pricing, are automatically populated into the contract based on the information from the orthodoxy table and the specified maturity key date.

It's important to note that the choice between an orthodox or non-orthodox approach can impact valuation and varies among companies. While most companies prefer an orthodox approach to maintain consistency and predictability, some may opt for non-orthodox approaches based on their specific requirements or trading strategies. If you decide to override the maturity key date during contract creation, it's crucial to carefully evaluate the valuation implications and ensure alignment with the chosen pricing approach. Consistency in pricing strategies helps mitigate risks associated with non-standard approaches and supports effective risk management.

BRFPlus tables are Commodity Pricing Engine (CPE) decision tables that are used to complete the master data required for determining the logic of formula assembly and the basis IDs that are used in the process. The BRFPlus tables in SAP Agricultural Contract Management are configured separately for the purchase and the sales side.

It is important to note that the configuration of rule sets, decision tables, and other aspects of the pricing logic is specific to each company's requirements. These configurations are not delivered as standard components and need to be set up by the customer according to their desired pricing strategies and business needs.

Here is an example to illustrate how the formula key is derived for procuring soybeans. The valuation point input into the contract is analyzed, condition types are assigned for futures and basis, including the components for the provisional price, the market price is specified and a validity period is also specified.

When the valuation point is found in the contract and matched with the condition records, the formula key is determined. There are different formula keys for futures, basis, market basis, secondary basis, and primary basis. When the formula key is obtained, it serves as a configuration object that helps determine the appropriate DCS for futures prices and the basis prices for both primary and secondary, as well as market pricing. This information is stored in the configuration tables.