Opinion: How blockchain and digital coins can serve the biofuels industry
Few topics in business today stir more debate than blockchain and digital coins. It is important, however, to not get distracted by the hype and polarisation of that discussion. Blockchain and digital coins are technologies that can bring important changes to the commodities markets, and for that reason are receiving growing attention and investment from players in the oil, natural gas, metals, agriculture, power, and emission rights industries, among others. Biofuel market participants should also follow these technological developments closely. There are three areas particularly promising to the biofuels industry: supply chain integrity and traceability, access to financing, and downstream sales.
Increasingly, the management of commodities supply chains requires the ability to track products from source-to-sink. Today’s prevalent method to do so is a combination of diligence, trust and a complex and expensive system of overlapping 3rd party audits and verifications. However, such 3rd party assessment are mostly used privately and not subject to public checks and scrutiny. Therefore, such reports are vulnerable to tempering. Further, the lack of public verification on representations around a commodity often leads to a belated discovery of fraud, when different parties reach for the same asset. The weaknesses of the current method are best evidenced by some high profile cases, such as the large-scale fraudulent sale of Renewable Identification Number (RIN) in the United States or the multiple sale of the same warehousing space in the Qingdao Port in China.
Blockchain offers a potentially superior solution to supply chain management. While the technology has many layers, there are six key broad capabilities that are particularly relevant: It creates an immutable digital record of the title of a real asset; It creates an immutable digital record of any transfer of such asset; It can automatically crosscheck these new digital records against a public global ledger that contains all digital assets and their history of transfers; It can carry these tasks in an automated and very decentralised manner, in such a way that the system is immune to the disruption of any of its parts; The records created and the results of the crosschecks are subject to extensive public scrutiny that precludes any form of tempering; Parties’ real identities can be concealed in the form of unique serial numbers.
These critical aspects of the technology carry several commercial implications. The immutability and cross checking of the records provide the confidence on the integrity of the asset traded electronically. The immutable recording of all transfers creates a reliable history to trace the asset from source-to-sink. The decentralised nature of the system means it is operationally reliable and resilient. Real identity concealment allows for the system to be used without jeopardising commercial interests. Automated and online, the system cuts transaction time and costs for the transfer of assets across the supply chain. These commercial implications explain the growing number of pilot tests being carried or planned for several commodities. Mercuria announced in 2017 the first publicly known and successful test with blockchain in oil trading. In early 2018, Dreyfus announced its first blockchain transaction for agricultural commodities. Similar initiatives have been publicly announced for metals, LNG, diamonds, cobalt and emission rights. Shell acquired in early 2018 a minority stake in a leading blockchain developer.
Commodity financing will change quickly in the years to come. As central banks reverse the post-financial crisis quantitative easing, and the implementation of recent and forthcoming regulations, such as Mifid II and Basel III, take effect, commodities financing, particularly for small and medium-size commodities firms, will be less available and more costly. For biofuels, which has a limited pool of banks and investors that understand and fund the sector, the impacts will be more acute. What would happen if a producer, rather than just counting on a small pool of financiers, could also access a global and efficient platform with millions of retail investors, accredited investors, family offices and institutional funds? What if the producer could offer investors a liquid secondary market for their investment? What if the producer could set customised terms for its needs, rather than having to meet or compromise on the conditions required by traditional commercial banks or equity investors? The sheer potential volume of willing new investors to fund a commodity company and the potential secondary market liquidity to such investment should lower funding costs, and possibly tip the balance of power to companies as they would have more room to require terms customised to their specific business and cash flow needs.
The global market for digital coins offers that potential opportunity. It is today an online, global ecosystem that includes tens of millions of investors (retail, accredited, funds), an efficient, global infrastructure to process funding transactions and a functioning infrastructure, with multiple exchanges, to handle secondary trading of digital assets. To understand what this means in practice, consider a company called WePower, which operates in the production and sale of renewable power. It recently issued digital coins to fund its rollout. It reports that expression of interest from investors came from over 190 countries and reached nearly US$300 million (€246 million). It capped its fundraising to its original target of US$40 million (€33 million), which came from investment funds and over 22,000 individual investors. There is no interest rate associated to the funding, no repayment obligations, no recourse rights or rights to equity in the company. Rather, in accepting the terms set by the company, investors agreed to tie their returns to the future demand for the company’s services. These are terms that would simply be not available from traditional financing sources.
However attractive these funding terms may be, digital coins and blockchain are no panacea for fundraising, not the least because regulations around digital coins in most countries are a work-in-progress and digital coin-related agreements have yet to be tested in courts. Yet this example, which is not a unique case, shows that companies may increasingly be able to access in a very efficient way a much larger, and global pool of financiers that may offer more flexibility on terms than the traditional sources of commodity financing.
The third promising area is downstream sales. The possibility of digitalising an asset opens up a range of new commercial possibilities. At the retail level, blockchain and digital coins enable a separation of payment and ownership from delivery, enable sales of a very small fraction of the product, and can handle efficiently interactions with a very large number of individuals or firms. RoyalMint, a British governmental entity that owns large inventories of gold and markets them to retail and institutional investors, created its own private blockchain-based trading system where each coin is backed by a set amount of gold, which RoyalMint holds in reserve. It also created small fractions so as to enable small transactions, with some constraints as to what is redeemable physically considering the practical issues about delivering physical gold. The objective was to expand its customer base by simplifying the way gold could be purchased, and increase revenues from gold sales. The initial results, as reported by RoyalMint, are quite positive.
There could be similar applications to biofuels. Imagine a fuel company that issues coins, e.g. 1 coin equals one gallon of biodiesel or ethanol or one MMBTU of biogas, and offer those coins to car or fleet owners via that fuel company’s own private blockchain-based trading system. Now consumers would also have the option to buy those coins online and in advance to, at some point in the future, redeeming them against actual fuel at a gas station. If fuel prices are low, now a car or fleet owner could buy coins to guarantee that low price for the fuel it will need during the next several months. The customer behaviour could be similar to that seen often in competitive retail power markets where residential and commercial consumers monitor power prices closely and try to whenever possible lock-in via different plans low power prices for the next several months. The fuel company, in practice, has now a tool to lock in future retail sales, anticipate the cash flow from its downstream operations, and potentially avoid or reduce fees paid to card payment firms at the point of sale as the fuel company would sell those digital coins directly to its consumers. If adopted on a large scale, it could have significant impacts on the working capital needs of such companies.
All these applications for supply chain management, financing and downstream sales are today potential opportunities. Whilst many use cases are in the pilot stage and those already operational have only a short history, these examples point to a rapidly growing volume of experimentation and applications of these technologies to commodities. To biofuels players, these examples underscore the need to not be left behind, and start assessing if and how such technologies can advance their individual businesses and the biofuels industry as a whole.
This article was written by Fabio Nehme, the managing director of Nehme Commodities, an international investment, trading and advisory firm specialised in commodities and digital assets. Contact: fabio.nehme@nehmecommodities.com
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