What if commodity producers and investors could trade the source attributes of any commodity, whether crude oil, natural gas, or agricultural products, just like futures and other derivative contracts for physical commodities trade today?
“Carbon today is the primary component for the production of fuels and electricity. Water is the key input factor across all agriculture products. Neither is valued in any conventional commodity price today,” says Joe Madden, the CEO of commodity market technology firm Xpansiv CBL Holding Group (XCHG).
This blind spot in commodity pricing is likely to change dramatically over the coming decade, driven by global resource constraints, increased demand for investments that screen demonstrably for ESG criteria, and the rapid proliferation of available (and increasingly standardized) data across financial asset classes.
As a result, XCHG is building a parallel trading market for differentiated commodities—an “intelligent commodities” exchange. This evolution will add clarity and precision (and perhaps even more liquidity) to the multi-trillion-dollar market for global commodities, a market that still relies largely on analog trading infrastructure from more than a century ago, when data itself was the scarcest resource.
“The intersection between markets and science has revealed major risk factors,” Madden says. “While it’s early days, the market has identified things that add risk, and this information is now becoming ubiquitous—things that were invisible are now in the spotlight. But responsible producers are still being lumped in with companies and products that are not managed well.”
XCHG’s market prediction comes at an auspicious international moment. Earlier this month, the European Investment Bank (EIB)—the world’s largest multilateral financial institution—announced that it will stop financing fossil fuel projects like oil, gas, and coal extraction after 2021, as part of Europe’s bid to become carbon neutral by 2050. Policy shifts like this one will heighten the need for reliable information on offsetting energy production protocols.
Demand is also coming from traditional energy-intensive industries, such as airlines. Besides the sector’s usual sensitivity to jet fuel pricing, global airlines are confronting the ambitious terms of the United Nations’ CORSIA scheme to offset aviation emissions after 2020.
XCHG has also registered increasing interest in source data for differentiated commodity trading from downstream utility companies and power generation firms.
There is a market precedent for this approach. Renewable energy credits (RECs) trade as proxies for a single MWh of energy generated from a qualifying renewable resource. Each credit is assigned a serial number for contract settlement, and contains a bundle of clean-energy attributes associated with the energy production for that resource. REC buyers can then attach those attributes to conventional power, so that a traditionally fossil fuel-based downstream commodity like electricity can be claimed as “wind power.”
There is a contract precedent as well. Henry Hub basis contracts used for the pricing of natural gas and LNG relate to a specific gate location. In the future, contracts for Henry Hub will reflect pricing differentials based on factors like methane intensity and water usage.
And there are recent transaction precedents for differentiated commodities. In September 2018, the first sale of responsible natural gas was struck when Southwestern Energy sold IES gold-rated TrustWell Responsible Gas—a third-party certification based on risk profile and performance on emissions ratings and operational controls—to New Jersey Natural Gas.
So while XCHG hasn’t created this market from whole cloth, its technology can enable the market to scale. Rather than selling specified “responsible” volumes of oil and gas, they instead sell the attributes of responsible production as a single unit of what the firm calls Digital Feedstock.
XCHG records key attributes of production (such as certified low-methane emissions at the wellhead or downstream) at the time that a commodity is produced. Digital Feedstock is the standardized, real-time digital format of this information, which is then structured, transacted, and referenced within a distributed ledger, so that it can be accurately priced into the contract. This “accountable differentiation” behind Digital Feedstock enables it to trade credibly as a non-financial digital asset, priced on a spot market.
Like a renewable energy credit, one unit of Digital Feedstock equals the attributes attached to one unit of commodity production, such as a physical barrel of oil or a million British thermal units of natural gas, and can be traded alongside the commodity. The digital asset—the “attribute”—can also trade separately from the reference commodity in an offsetting transaction.
Presently these contracts settle on XCHG’s own CBL Markets exchange, an Australian-based, regulatory compliant marketplace for the transaction of spot contracts on complex physical commodities.
Earlier this month, XCHG rolled out its own major test case for the differentiated commodities market, partnering with sustainable cement manufacturer Solidia Technologies on a tradable contract priced to reflect the carbon, water, and energy attributes of cement and concrete.
Venture capital from oil majors and other investors is propelling the company’s expansion, with BP Ventures, Grail Partners, S&P Global, and the energy tech fund Energy Innovation Capital on the current roster of funders.
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Perhaps most compelling to investors—especially those who’ve been burned before in the commodity pits—is that Digital Feedstock is price-agnostic. Demand for production attributes will likely not rely on the underlying price dynamics of crude oil or other indexed commodities.
Instead, XCHG is betting, the real bull market will come from tapping the data well.