Commodity Trading Guide: How Physical Trade Works
From cargo to counterparty: the mechanics of physical commodity trade.
What a physical trader does
A physical commodity trader buys a cargo in one place and sells it in another, at a different time, in a different form, or to a different counterparty. Value comes from resolving mismatches in location, time, quality and credit — not from directional price bets, which are usually hedged out.
Contract building blocks
- Incoterms — who bears cost and risk at each stage (FOB, CIF, DES and others).
- Quality specification — the tested parameters the cargo must meet.
- Quantity tolerance — the permitted variation on nominated volume.
- Pricing mechanism — fixed, floating against a benchmark, or formula-based.
- Laytime and demurrage — the time allowed for loading and discharge.
Logistics
Freight is a cost and a risk. Voyage economics, port restrictions, congestion, storage availability and inspection scheduling all shape whether a paper arbitrage is executable in practice.
Trade finance
Physical trade is working-capital intensive. Letters of credit, receivables finance, borrowing base facilities and inventory financing bridge the gap between paying for a cargo and being paid for it. Bank appetite and credit terms are as decisive as price.
Risk management
- Price risk — hedged with futures, swaps and options.
- Basis risk — the residual gap between the hedge and the physical exposure.
- Counterparty and credit risk — managed with limits, security and insurance.
- Operational risk — quality, delay, loss and documentation failure.
- Compliance risk — sanctions, provenance and know-your-counterparty checks.