What is a Finalization?

Following on from yesterday's post about provisional pricings comes a closely related concept - finalizations. But finalizations aren't just about price. Almost all physical contracts will require some form of finalization before they can be considered complete.

Physical contracts are usually booked using round numbers - 1,000mt of metal, 200,000 bbls of oil, or 100,000 bushels of wheat. In reality, the final quantity almost never matches the original contract volume exactly.

Most physical contracts include shipment tolerances to allow for small over or under deliveries. Whether the material moves in containers, bulk shipments, trucks, railcars, or pipelines, there will almost always be some difference between the contractual quantity and what is ultimately delivered.

It is also very common for contracts to be priced before the final quantity is known. Once the final weight has been agreed, the contract must be finalized so that it reflects the true value of the transaction.

This adjustment will have a knock-on effect throughout the trade.

Invoices raised using the original contractual quantity must be corrected to ensure the correct funds are transferred. Hedges must also be adjusted to ensure companies are not over or under hedged. You might not think that a 2% variance is a big deal, and on a single contract you might be right. But on an entire trading book over the course of a year, these small imbalances can quietly accumulate and can cause significant losses.

Finalizations aren't always driven by quantity either. For commodities that require assaying - taking samples to obtain the exact chemical composition of the commodity - the payable amount itself can change.

Take a 20,000 dmt parcel of copper concentrates that was bought at 25% contained copper based on provisional assays. If the final assay comes back at 24.5% copper, that payable volume falls by 100mt. With copper at $13,000/mt, that single adjustment changes the value of the transaction by ~$1.3m, while also requiring the hedges to be amended.

Finalizations often occur at month-end, precisely when operations, accounting, and risk teams are under the greatest time pressure. It can become easy to treat them as an administrative task, or even overlook them completely.

In reality, finalizations are one of the most important controls in physical commodity trading. Failing to complete them in a timely fashion allows small discrepancies to quietly snowball into very large losses.