What is a Gross Processing Margin?
Gross processing margin (GPM) is the difference between the cost of a raw commodity and the income it generates once sold as a finished product. Gross processing margins are affected by supply and demand. The prices for raw commodities and their processed versions fluctuate, creating an ever-changing spread between the raw inputs and the processed products. Investors, traders, and speculators are able to trade futures based on their expectations about changes in gross processing margins for particular commodities.
Understanding a Gross Processing Margin (GPM)
The gross processing margin can go from generous to thin on a season basis, as well as from unexpected weather events or regional turmoil in an area that is a significant producer of a commodity. When the spread for the gross processing margin widens, meaning that the pricing of the outputs is handily exceeding the cost of the inputs, that is generally seen as a signal for capacity expansion. The gross processing margin usually increases for one of two reasons. One, the input commodity sees a glut, possibly due to overproduction or simply luck, and the input price weakens significantly. Two, the price for the processed products rises due to increasing demand. For the health of the whole value chain, investors generally want to see the GPM increasing for the latter reason as it represents more sustainable industry growth.
Gross Processing Margins and the Type of Processor
The gross processing margin for two businesses using the same raw commodity can be very different depending on the end product mix. This applies to everything from soybeans to crude, but it is easiest to understand in terms of livestock and meat. Two pork processors are working with the same raw commodity, but if one simply sells whole cuts frozen and the other sells a range of value added products including bacon, sausages, and marinated loins, then their gross processing margins will likely reflect that product variance. The frozen wholesaler has lower costs of production but similar procurement costs. The value add focused processor puts more cost and time into the meat, but should see a much higher premium upon sale. That said, seasonal supply and demand is the major driver for overall industry gross processing margins. There are seasonal trends in all the soft commodities and even the hard commodities go through seasonal cycles that slow extraction activities.
Commodity Specific Names for Gross Processing Margin
Gross processing margin may go by a different name depending on the commodity it is describing. For example, the GPM for oil is called the crack spread in a reference to the refining process cracking hydrocarbons into petroleum products. For soybeans and canola, it's called the crush spread because soybeans are crushed to produce oil and meal.