Commodities: Tougher times for trading titans; Reaping the supercycle: the top 20 trading houses have posted almost $250bn of net profit over the past decade

April 14, 2013 7:46 pm

Commodities: Tougher times for trading titans

Reaping the supercycle: the top 20 trading houses have posted almost $250bn of net profit over the past decade

By Javier Blas

If you want to raise $10bn quickly, you need to know who to call. When Igor Sechin, chairman of Rosneft, decided to buy TNK-BP and create the world’s biggest listed oil producer, he faced a problem: banks would not be able to provide the full $55bn required.

So Mr Sechin went elsewhere. Late last year, he phoned two of the world’s trading titans: Ian Taylor and Ivan Glasenberg, the chief executives of Vitol and Glencore. In a matter of weeks, the trading houses offered a $10bn loan that the state-owned Russian company guaranteed with future supplies of crude. Vitol and Glencore were financing one of the largest deals in the history of the oil industry. “We have never seen the trading houses embarking on a deal of this scale,” says a banker who helped to put together the contract. “We are in new territory.”The Rosneft deal was finally concluded on March 21.

The size of the loan offers a vivid example of the formidable and growing role of obscure trading houses, whose names are relatively little-known outside a community of dealers specialising in energy, metals and agricultural commodities. Enriched by China’s voracious appetite for raw materials, the world’s top 20 trading houses have reached unparalleled levels of influence over the past decade.

The full scale of the trading houses’ ascent has emerged from a review by the Financial Times of thousands of pages of documents, from bond prospectuses to confidential investor presentations and legal filings. The scale of their operations has long been hard to determine. Eleven of the 20 biggest houses are either unlisted or have only recently been required to present filings to exchanges. The documents, coupled with dozens of interviews with executives, bankers and consultants, give a rare insight into the increased reach that the traders have gained worldwide.

Critically, the documents reveal profit growth moreredolent of the explosive development of Silicon Valley start-ups than the centuries-old business of trading. The world’s top 20 independent commodities traders posted a record net profit of $36.5bn in 2008, soaring about 1,600 per cent from $2.1bn in 2000. Over the past decade those 20 trading houses posted profits of $250bn – more than the world’s top five carmakers combined.

Mr Glasenberg stresses that one decisive factor has underpinned this dizzying transformation. “Growth has been, and will remain, closely linked with China’s,” he says, “especially since the country’s entry into the World Trade Organisation over 10 years ago.”

Trafigura exemplifies the boom that Beijing has helped to fuel over the past decade. According to filings in Amsterdam, the company was a sleepy trader at the beginning of the commodities supercycle, registering a profit of just $24.2m in 2000. Last year the figure was $991m, down slightly from a record $1.1bn in 2011. Vitol is another example. The world’s largest oil trader made almost no money in the late 1990s, struggling to keep itself above break-even between 1996 and 1999. In 2000 it made $296m. By 2009 its profits had surged to $2.28bn.

All this has been built on revenues that have reached extraordinary highs. Sales from 10 of the world’s largest independent commodities trading houses – Vitol, Glencore, Trafigura, Cargill, Mitsubishi, ADM, NobleWilmar, Louis Dreyfus and Mitsui – last year hit $1.2tn, roughly equivalent to the gross domestic product of Spain or South Korea. Vitol alone had revenues last year of $303bn, slightly less than the GDP of Denmark.

But the FT’s review also shows that, for the first time since the commodities supercycle started more than a decade ago, the industry is now facing strong headwinds as Chinese growth slows. Glencore’s net profit last year cooled to $3.06bn from the $5.2bn peak in 2007. Vitol posted $1.05bn in profit last year, less than half of the bumper $2.28bn in 2009. Cargill’s net income fell to $1.17bn in 2012, a sharp descent from the record of $3.95bn in 2008.

“Times have changed; slower growth and intense competition are eroding margins across the board,” says Ian Taylor, chief executive of Vitol. “As companies grow, return on equity is bound to fall – this is compounded by a tough market environment,” he adds.

Still, the rapid ascent of the traders over the past decade has sparked alarm among non-governmental organisations and lawmakers. Critics accuse trading houses of distorting food and gasoline prices through speculation and say that they enjoy cosy relationships with regimes notorious for human-rights abuses, such as Iran and Sudan.

“The surge in profits illustrates the necessity of closing the huge transparency gap of the commodities trading industry,” says Oliver Classen of the Berne Declaration, a non-governmental organisation pushing for greater oversight. “The industry right now is a black hole.”

Competitors are also daunted by the companies’ extensive intelligence networks. The traders monitor supply and demand worldwide – data that they then use for arbitrage trading. At its most basic level, they deploy people to count cocoa stocks in Ivory Coast or set up cameras to film coal stocks at Japanese power stations – all to determine the inventory fluctuations and price discrepancies through which they make their millions.

An even more controversial advantage for the trading houses, which now sets them apart from the big banks, is that they are largely unregulated. This too is causing consternation, particularly as the houses step into a funding void vacated by western banks. The government of Switzerland, the main hub of the trading titans, recently acknowledged the challenge in unusually candid language for an official report: “Physical commodities traders are, in principle, not subject to any oversight.”

These advantages are boosted by an unusually low tax burden, with the commodities traders paying considerably less than oil or mining groups, or indeed Wall Street banks.

The traders have preserved a remarkable level of anonymity despite such a crucial role in the daily supply of energy and food. The leading independent energy trading houses – Vitol, Glencore, Trafigura, Mercuria and Gunvor – together handled more than 15m barrels of oil a day last year – more than enough to meet the import needs of the US, China and Japan. Agriculture is similar: the so-called “ABCD” group of ADM, Bunge, Cargill and Dreyfus, that dominates global agricultural markets, handles about half of the world’s grain and soyabeans trade flows, executives say. Glencore and Trafigura form a duopoly that controls as much as 60 per cent of some markets, such as zinc.

In niche markets, such as coffee, sugar, cocoa or cotton, relatively unknown companies command extraordinary power. Neumann Kaffee Gruppe is a good example: the Hamburg-based family-owned trader is behind the beans that go into one in seven cups of coffee worldwide. Ecom Agroindustrial mills more coffee beans than any other company. Almost unknown to the public, the Swiss-based trading house counts among its clients household names such as Nestlé and Starbucks , according to a World Bank document.

Commodities trading is as old as civilisation itself. But the development of the industry accelerated in the 1970s and 1980s as a new breed of more aggressive trading houses emerged.

These included Marc Rich + Co, the precursor to Glencore founded by former fugitive Marc Rich – and John Deuss’s Transworld Oil. In the past decade, the industry has experienced its most rapid transformation, fuelled by four pillars of growth.

First, the economic boom in emerging countries after 2000 triggered a huge expansion in commodities trade. Data are scant but estimates for grain trade from the US Department of Agriculture illustrate the forces at play. The USDA estimates that global grain trade surged 20.9 per cent between 2001 and 2010, compared with an increase of just 1.9 per cent between 1991 and 2000, and a drop of 0.9 per cent between 1981 and 1990.

Second, although traders do not generally profit from the ups and downs of the market but rather from price fluctuations between locations, a push into investing allowed them to profit from the supercycle. Starting in the late 1980s, some trading houses – with Glencore and the Japanese sogo shosha at the forefront – began to invest in assets: oilfields, mines, refineries, smelters and farmland. When the price of commodities surged, so did the value of their assets – and their production.

Third, tight markets greatly helped the traders. When surging demand overwhelmed supply, traders profited from the arbitrage opportunities offered by an abundance of price discrepancies between regions.

Finally, competition dropped. The lean period of 1985 to 2000 put many trading houses out of business. Others collapsed when price volatility surged from 2000 onwards. André & Cie, one of the largest traders of agricultural commodities, failed in 2001. Some big traders bought rivals; Cargill bought Continental in October 1998.

The oil mega-mergers of the late 1990s and early 2000s also helped to cut competition. The buyers – companies such as Exxon and Chevron
with a “non-trading” culture – acquired groups with a trading pedigree, including Mobil and Texaco. In the merger process, the non-trading culture won, eliminating several competitors.

However, the trading houses are losing this last advantage. Over the past few years, competition has picked up. Wall Street and the City of London have ventured into physical commodities trading, with Morgan Stanley and JPMorgan moving huge volumes of raw materials such as fuel oil and aluminium on top of their traditional banking business of providing financial derivatives in commodities.

The trading houses have now grown so big – and their strategic importance so vital – that regulators, spooked by the cooling supercycle, are now asking whether they have become “too big to fail”, like banks and insurance companies.

Timothy Lane, deputy governor of the Bank of Canada and a key policy maker at the Financial Stability Board, the Basel-based body that co-ordinates financial regulators, articulated the fears of many regulators in a recent speech, saying that the increasingly prominent role played by large trading houses “raises the possibility that some of these institutions are becoming systemically important”.

Others see such fears as exaggerated. Two major trading houses failed over the past 12 years without sparking disaster. Enron, which collapsed in 2001 after widespread accounting fraud, is the prime example, says Craig Pirrong, an expert in commodities trading at the University of Houston: “An entire commodity trading sector – the merchant energy sector in the US – imploded without disrupting the financial system, or the trade in physical power and gas.”

Still, if Mr Lane is right, the job of overseeing a complex global network of traders will be a daunting one for the regulators.

Incentives: low tax burden fuels the ascent of the traders

Low tax has proved to be a strong tailwind for the commodities traders. Other companies in the resources industry such as mining and oil groups pay on average an effective tax rate of 30-45 per cent. Wall Street banks pay about 20 per cent.

By contrast, the commodities’ traders pay 5-15 per cent as they take advantage of tax breaks in countries such as Switzerland, Cyprus, the Netherlands and Singapore.

For example, Mercuria, the world’s fourth-largest independent oil trader, said in its annual 2011 accounts filed in Larnaca, Cyprus, that “the group operations are located in jurisdictions with tax rates of 9.5 and 10 per cent”.

Low taxation is in part the product of a race to attract companies to base their operations in cities such as Hong Kong, Dubai, Kuala Lumpur and, above all, Singapore.

The Asian city-state has run a scheme called the “global traders programme” since June 2001, which offers a corporate tax rate of 10 per cent to traders.

Commodities trading houses can qualify for a 5 per cent rate if they commit to certain criteria including hiring required numbers of local staff and making significant use of Singapore’s banking and financial services.

“The programme encourages global trading companies to use Singapore as their regional or global base,” says International Enterprise Singapore, the government agency promoting the city.

Other places are replicating the model of ultra-low taxes to attract trading houses, and are even offering rates as low as zero.

Dubai and Hong Kong, for example, have both introduced programmes for trading houses with no taxes.

Kuala Lumpur is offering a tax holiday for the first few years for companies dealing in certain commodities.

But Switzerland, the biggest hub of the industry, is about to increase tax rates for the commodities traders, lawmakers say.

Geneva will raise the effective tax rate that the traders pay from about 10-11 per cent now to 13 per cent by 2018. Other cantons, including Zug, are likely to follow.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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