The best kept money making secret on Planet Earth today.
For the small club of companies who trade the food, fuels and metals that keep the world running, the last decade has been sensational. Driven by the rise of Brazil, China, India and other fast-growing economies, the global commodities boom has turbocharged profits at the world’s biggest trading houses.
Who are those firms and what makes them so powerful?
They are the Club of 16 comprised of Vitol, Glencore, Cargill, Koch Industries, Archer Daniels Midland, Gunvor, Trafigura, Mercuria, Noble, Louis Dreyfus, Bunge, Wilmar International, Arcadia, Mabanaft, Olam and Hin Leong.
Together, they are worth over one trillion dollars in annual revenue and control more than half the world’s freely traded commodities. Many amass speculative positions worth billions in raw goods, or hoard commodities in warehouses and super-tankers during periods of tight supply.
How big are the biggest of them? Well, take Vitol and Trafigura as an example, they sold more oil last year than the oil exports of Saudi Arabia and Venezuela combined and their reach is only expanding.
Big trading firms now own a growing number of the mines that produce many of our commodities, the ships and pipelines that carry them, and the warehouses, silos and ports where they are stored. With their connections and inside knowledge — commodities markets are mostly free of insider-trading restrictions — trading houses have become power brokers, especially in fast-developing Asia, Latin America and Africa. They are part of the food chain, yet help shape it, and the personal rewards can be indeed huge.
Look at it this way. Most commodity buyers in the world are price takers. The top trading firms are price makers. It puts them in a tremendous position. This is the sort of position that has for example allowed Vitol to do a brisk oil business with the U.S. government, the besieged Syrian regime, and Libya’s newly empowered rebels simultaneously over the past year. Trading houses were able to do this because international sanctions on Syria do not ban the sale of fuel into the country, but they did not have to fight off much competition for that business.
So how do these money machine behemoths really make their money?
For many commodities traders, the most profitable ploy has been the squeeze, which involves driving prices up or down by accumulating a dominant position. In the early 2000s, the Brent crude oil stream — used as a global price benchmark — fell to 400,000 barrels per day from more than 1 million in the late 1980s. A few traders seized the chance to buy what amounted to almost all the available supply. Price premiums for immediate supply spiked, sapping margins for refiners worldwide. U.S. refiner Tosco sued Arcadia and Glencore for market manipulation; the case was settled out of court.
In metals, stock in warehouses can be tied up for years as loan collateral, allowing the same traders who dominate the metals market to control a huge chunk of world supply — an apparent conflict of interest that has drawn criticism from the UK parliament.
The warehouses seem to have an infinite capacity to absorb metal, but a very small capacity to release it. Trading houses saw the opportunity to leverage metals warehousing after the 2008 financial crisis. Of the six major metals warehousers only one, Dutch-based C.Steinweg, remains independent. Trading houses competed with banks for the spoils — Glencore, Trafigura and Noble took one warehousing company each, Goldman and JP Morgan the others.
And unlike commodities producers, such as U.S. oil giant Exxon Mobil, trading firms don’t just make money when prices go up. Most rely on arbitrage — playing the divergence in prices at different locations, between different future delivery dates, or between a commodity’s quality in different places.
What does the future hold?
Although U.S. and European regulators are cracking down on big banks and hedge funds that speculate in raw goods, trading firms remain largely untouched. Many are unlisted or family run, and because they trade physical goods are largely impervious to financial regulators. Outside the commodities business, many of these quiet giants who broker the world’s basic goods are little known.
U.S. regulations are now pending to limit banks’ proprietary trading — speculating with their own cash. The new rules don’t apply to trading firms. Trading houses have huge volumes of proprietary trading. In some cases it makes up 60-80 percent of what they do. They have the most talent, the deepest pockets, and the best risk management.
In addition to proprietary trading curbs, U.S. regulators voted to impose position limits in oil and metals markets. That gives banks who trade futures cause for concern, but since physical players usually receive exemptions to limits — because they are categorized as bona fide hedgers — trading firms should go unscathed.
My personal opinion
I only see more power in the years and decades ahead for physical commodities trading firms as a number of global private equity funds will be soon joining the “trillion dollar club”.
Major oil companies are already selling more than $300 billion of assets, according to Carlyle International Energy Partners. So no wonder we will see more private-equity companies, commodity traders and sovereign-wealth funds buying more energy infrastructure from oil companies shifting to expensive exploration and production projects.
Global commodity traders are also already massively investing in infrastructure to expand their trading opportunities and secure supplies; same goes for sovereign wealth funds teaming up with commodity traders to fund purchases of energy assets. Many more players are positioning themselves very aggressively in Africa and Southeast Asia. Not sure yet about North America as regulators are not helping lure such players to our shores.
A private money manager like a sovereign-wealth fund might still lack the interest and the expertise to manage a 10-year oil delivery contract with a major driller —smart traders though learn fast.
Step aside Wall Street – Your monopoly over brainpower and wealth creation is in its last days with squeezing margins and increasing financial regulation the world over.
Welcome to the new breed of wealth creators and masters of the universe in the making.
Share your thoughts…