What is Provisional Pricing?

In physical trading it is common for an invoice to be issued before the final price of the material has been determined. In these situations, the seller raises an invoice using a provisional price.

Imagine you are selling 1,000mt of copper. The cargo has been shipped but instead of agreeing a final price immediately, both parties agree that the price will be determined using a future pricing period, perhaps the average price of the month after the month of shipment (commonly referred to as M+1).

The seller has already delivered the material and needs to be paid, so rather than waiting until the final price is known, the buyer makes a provisional payment based on the current market price.

For example, if copper is trading at $13,000/mt when the cargo is shipped, the buyer may make a provisional payment using that value. Once the agreed pricing period has finished, the final invoice is calculated and any difference is either paid by the buyer or credited back by the seller.

If the final price settled at $13,500/mt, the buyer would owe the seller an additional $500/mt. If the price settled at $12,500, the seller would credit the buyer $500/mt.

Some sellers take an additional step to protect themselves and deliberately use a provisional price above the current market, typically ~10% higher. By doing so, they reduce the risk that the buyer would owe a substantial payment if the market rallies significantly before final pricing, but after title to the commodity has already transferred. Any overpayment is reconciled when the final invoice is issued.

An important point to remember is that no hedge should be executed at the point of provisional pricing.

The provisional invoice exists purely to facilitate cash flow between buyer and seller. The commodity remains fully exposed to price movements until the final pricing mechanism has been completed. The hedge should instead be executed at the point of fixing the contract price. Hedging at the point of provisional invoicing could actually be creating a price exposure rather than mitigating one.

Understanding the distinction between provisional and final pricing and where hedging fits into the process is critical to how many physical commodity transactions are priced and managed.