Banks’ retreat empowers commodity trading houses
Over the past decade, the world’s largest banks have with little fanfare become immersed in a business far removed from their traditional lending activity: the trading of physical commodities.
Morgan Stanley was one of the largest shippers of fuel oil to New York Harbour. Deutsche Bank at one point held enough aluminium to build 30,000 jumbo jets, and JPMorgan helped ship Brazilian sugar to buyers around the world.
But now the banks are retreating from the sector en masse. The once-in-a-generation shift is empowering little regulated and largely privately owned commodities trading houses such as Vitol, Trafigura and Louis Dreyfus Commodities to consolidate their control over supply chains for food, oil and metals.
“As banks retreat from the sector, independent traders will take over some of the roles previously covered by the banks,” says Roland Rechtsteiner, a commodities expert at consultants Oliver Wyman.
The retreat of the banks has been driven by tighter regulation, fresh capital constraints and lower profitability due to stable prices for oil and commodities. Coalition, a consultancy, estimates the revenues of the top 10 banks in commodities fell last year to $4.5bn, down from a record $14.1bn in 2008.
Deutsche Bank, one of the five biggest players in commodities over the past decade, has almost completely abandoned the sector, as have UBS and Royal Bank of Scotland. Barclays is also shrinking its presence, while Morgan Stanley, one of the original “Wall Street refiners” has agreed to sell its oil trading unit to Rosneft, the Russian state-owned oil company.
Only Goldman Sachs, one of the first banks to enter commodities markets 30 years ago, appears to be strategically committed to the sector, earlier this year deeming it “too important to clients to exit”.
The shift has caught the attention of regulators. The UK’s Financial Conduct Authority noted this year, in its first report on the commodities sector in five years, that banks have reduced the scale of their commodities activities, while commodity trading companies have assumed a greater role.
“This trend may continue into the future, partly assisted by the evolving regulatory landscape, with non-bank entities able to leverage less stringent capital requirements and operate without enforced remuneration restrictions,” it said.
As the banks step back, the physical commodity traders are taking advantage. Some are buying businesses that the banks have lost interest in. In the most prominent example to date, Mercuria, a Geneva-based trading house founded just a decade ago by two former Goldman traders, has just agreed to buy JPMorgan’s physical commodities business for $3.5bn.
Ian Taylor, chief executive of Vitol, the world’s largest independent oil trading house, says the banks’ withdrawal has “created longer-term opportunities” for the physical trading houses.
One opportunity is in financing, where traders are becoming more active. Traditionally, banks lend to commodities producers and consumers. But increasingly the traders are doing it themselves, joining the world of shadow banking.
In a landmark deal last year, Vitol and Glencore agreed to lend $10bn to Rosneft to help it finance the acquisition of TNK-BP. In exchange, the trading houses received a guarantee of future oil supply, making it one of the largest pre-export commodities financing deals in history. Trafigura has struck a similar deal.
This new role for trading houses has raised eyebrows among policy makers, worried about the potential for creating another industry that is “too big to fail”. The Financial Stability Board, the Basel-based body that co-ordinates financial regulators, is already exploring the role of the commodities trading houses in the shadow banking world.
Traders are also developing a greater presence in industrial assets, highlighted by Vitol’s $2.6bn acquisition of a refinery and petrol station business in Australia from Royal Dutch Shell. In part this is a response to weaker “pure trading” margins, caused by increased competition and lower volatility, particularly in oil.
Christophe Salmon, chief financial officer for Trafigura in Europe, Africa and the Middle East, says that some trading houses have reinvested part of their profit into industrial assets that create synergies with trading.
“Logistical assets such as ports and terminals support recurrent trading flows; owning storage facilities reduces transaction costs and enables firms to smooth supply and demand shocks,” he says.
Not everyone is responding in the same way. Some traders are adopting an “asset light” model, such as Singapore-based Noble Group, which is poised to sell a stake in its agribusiness division to China’s largest grain trader, state-owned Cofco Corp. Mercuria is also keeping an asset-light strategy.
As trading houses invest greater amounts in industrial assets they are being forced to raise more capital from outside investors, in turn threatening the private ownership model historically favoured by the industry.
Some traders, such as Glencore Xstrata, are already publicly listed companies, but others are considering floats. Others are using hybrid strategies, tapping capital markets or seeking strategic investors, while maintaining the flexibility and lower public disclosure permitted by private ownership. Trafigura raised $500m last year from the sale of a 10 per cent stake in Puma Energy, subsidiary to Angola’s state-owned oil company.
Jan-Maarten Mulder, global head of commodities at ABN Amro, says that traders are unlikely to rush into IPOs. But he concedes: “Certainly, a number of players have prepared for a listing, whether it is for their own company or one of their assets. But I don’t expect it in the short term.”