Optionality.

What story do you see in these two images?  One shows different feedstocks used to produce biodiesel and renewable diesel.  The other shows the ingredients list on a bag of tortilla chips.

As a trader I see two products, each with their own unique optionality around feedstock choice.

In economics jargon, this is a manifestation of Arbitrage and Cross-Price Elasticity of Demand.  Definitions at the bottom if you care.

This optionality is the reason why the veg oil market has always been a playground for traders.  There are a dozen or more oils, each with their own niche (think baking, frying, dressings, biofuels, etc) and each with some level of substitutability.  Throw in geography, harvest timing, weather, and an ever increasing list of trade barriers, subsidies and mandates…and mercy, there’s no end to the opportunities to trade.

Food companies know this…its why their ingredients lists provide flexibility to take advantage of the low cost oil du jour.  Biofuel producers know it too.

As a trader with a flexible asset, like the company making those tortilla chips, it’s a great way to augment manufacturing margins as prices between oils move up and down.

As a trader with an inflexible asset (think a crush plant that only does soy, or a palm plantation) it’s a challenge.  In hard times, you can never get the price you need because someone, somewhere has a cheaper oil for sale.

And as a standalone trader…it often feels like the market you are positioning never goes as high, or as low, as your analysis suggests.

We had a running joke on the veg oil desk I used to work, “There’s an oil story…next year.”

Enjoy this crazy, unpredictable season in the veg oil world.  Hope these insights help. And if you need help finding ways to manage optionality in your commodity business, reach out.

Good luck and good trading.

As defined by Wikipedia:

Arbitrage is the practice of taking advantage of a difference in prices in two or more markets – striking a combination of matching deals to capitalize on the difference, the profit being the difference between the market prices at which the unit is traded.

Cross (or Cross-Price) Elasticity of Demand measures the effect of changes in the price of one good on the quantity demanded of another good. This reflects the fact that the quantity demanded of good is dependent on not only its own price (price elasticity of demand) but also the price of other “related” good.

Chart source: USDA FAS: Growing Demand for Fats and Oils Due to Global Biodiesel Expansion