Formula pricing (index-linked pricing)
A method in which the price is tied to a market index instead of a fixed figure – for example “LME copper average of the shipment month + USD 85/t premium”, “Platts Dated Brent + USD 2.50/bbl” or “ICIS PP homopolymer CFR Türkiye monthly average minus 1 %”. The pricing period (B/L month, arrival month or quotational period, QP), the index source and the exchange rate used for payment must be stated clearly in the contract. In term contracts it protects both parties fairly against price swings.
Related terms
Price reporting agencies (Platts, Argus, ICIS, Fastmarkets) PRA
Independent organisations that collect deals, bids, offers and market talk for commodities not traded on exchanges – or whose physical markets differ from exchange prices – and publish daily or weekly assessed prices. S&P Global Platts and Argus are benchmarks for oil, LNG, fertilisers and coal; ICIS and ChemOrbis for petrochemicals and plastics; Fastmarkets (Metal Bulletin) for metals, ores and paper; CRU for steel and aluminium. Their prices serve as indices in formula-priced contracts and are audited against IOSCO principles.
London Metal Exchange (LME) and commodity exchanges
The exchange that sets global reference prices for non-ferrous metals such as copper, aluminium, zinc, nickel, lead, tin and cobalt; its official prices and monthly averages are used as indices in physical contracts. A physical buyer pays the LME price plus a premium that depends on origin, brand and delivery location (e.g. the Rotterdam aluminium premium). Other key exchanges: CME/COMEX (copper, gold), ICE (Brent, cocoa, coffee, sugar, cotton), CBOT (soybeans, corn, wheat), SHFE (Shanghai metals), DCE and ZCE (Chinese plastics, iron ore and agricultural futures) and Bursa Malaysia (palm oil).
Spot purchase vs. term contract
A spot purchase is a one-off deal at the current market price for prompt delivery: flexible, but exposed to price and supply swings. A term contract secures regular shipments over a period (a quarter, a year) at a fixed or formula-linked price, giving security of supply but often with a minimum off-take (take-or-pay) obligation. Manufacturers usually balance risk by covering part of their needs on term and buying the rest spot.
Hedging (price-risk management)
Offsetting the price risk of physical buying and selling by taking an opposite position in derivatives such as futures, forwards, options or swaps. A cable maker taking copper in three months can buy LME copper futures today to protect against a price rise, while a trader that has sold at a fixed price sells futures. Forward FX contracts manage currency risk in the same way. Hedging is not speculation: the aim is to protect the margin rather than to make a profit, though margin calls and basis risk must be managed.