Shocks to the global trading system due to escalating trade disputes are being felt in a very niche business — the large-scale commodity trading houses that keep a low profile but have a huge influence on global trade with revenues running into hundreds of billions of dollars.
Commodity traders were some of the first to feel the heat, with metals, agriculture and energy trading desks hooked on to the US president’s Twitter account for market signals.
This weekend, sabre rattling between the US and China intensified, leaving many trading houses stuck with cargoes on the water or at loading ports, with uncertain destinations.
Unipec, the trading arm of China’s state-owned Sinopec, was scheduled to load eight VLCCs of US crude in June, but by the time they arrive at Chinese ports in two-months, Beijing’s latest tariffs may kick in. Others, like the trading arms of oil majors, play the role of producers, exporters and traders of US crude at the same time.
Trade-war risks have emerged for trading houses such as Glencore, Vitol, Trafigura, Gunvor and Koch.
Specialization has left them more exposed to individual commodities.
Traders have been entering new regions that others fear to tread, and stiff competition has pushed them into riskier trades.
This can be seen in the near-collapse of Noble Group, looming consolidation for the ABCDs in agriculture — Archer Daniels Midland, Bunge, Cargill and Louis Dreyfus — and tighter regulation such as Europe’s MiFID II rules. In early May, ADM warned that trade spats could cost $30 million in losses.
“Interruptions to global trade always existed and have always happened. It is the job of commodity traders to intervene in a supply disruption because they are the holders of prompt inventory,” Roland Rechtsteiner, partner at consulting firm Oliver Wyman, said recently in an interview.
ON THE FRONTLINES OF TRADE WAR
Geopolitical risks are not new, but risks are higher than ever because trade volumes have grown exponentially.
Trading houses’ long-term competitiveness is achieved through volume and market share dominance. It is estimated that the four largest agriculture traders control around 75% of the market. Other commodities also have fairly high concentrations of independent trading activity.
An Oliver Wyman study showed that trading margins were so thin that traders are forced to build up scale to reach critical mass, making big trades even bigger.
“The same few names — Glencore, Trafigura, Vitol, BP, and Shell — repeatedly were the ones carrying out the industry’s largest transactions,” Oliver Wyman said in its study last year titled The Endgame of Commodity Traders.
The quest for scale has triggered deals such as the Noble Group hiving off businesses to Vitol, Gunvor talking with potential acquirers, and Glencore circling US grain trader Bunge, the study said.
Others have boosted volumes, driven by market fundamentals or government mandates.
For instance, Unipec had plans to raise US crude shipments by around 80% to 200,000 b/d in 2018 from last year, competing directly with oil majors and trading houses, but also leaving it exposed to Beijing’s proposed tariffs.
RISQUE TRADES, TRADE ROUTES
Commodity traders were quick to jump onto new emerging trades with questionable counterparties and inefficient legal safeguards. When disruptions strike, things can go south quickly, such as the recent fiasco surrounding Russian aluminum producer Rusal.
“There is no indication that trading houses have built in sufficient legal fail safes into commodity contracts to deal with a trade war situation,” Paul Aston, senior partner at Holman Fenwick Willan, said recently.
A clause that companies would be tempted to trigger is that of force majeure, where parties may be “exempted from the performance of their obligations due to proscribed events or circumstances beyond their control,” he added.
It is unclear, however, whether a trade war constitutes a force majeure, because force majeure does not recognize economic hardship as a reason, although “prohibitions and or sanctions by government bodies may amount to such an event depending on the clause used,” he said.
Traders learnt this the hard way when Chinese buyers brazenly defaulted on US propane cargoes due to cheaper supply from the Middle East.
On April 10, a Texas court awarded a $523.8 million judgment in favor of German trader Mabanaft against China’s Oriental Energy Co. Ltd. for breaching a long-term contract for FOB sale of US propane signed in 2013.
For CFR cargoes, it gets even more complicated as three or four parties are involved, making a trade dispute even messier.
“Enforcement is typically a major problem. Chinese companies can put up road blocks that make it difficult for foreign companies to enforce court judgments,” Aston said.
TRADE WARS WIPE OUT ARBITRAGE
Due to the long distance, US-Asia commodity trades are highly sensitive to small changes in arbitrage economics and freight costs.
This happened in early April when China threatened to impose a 25% import tariff on US propane, and increased the import duty on US denatured ethanol by 15% to 45%.
This weekend, it threatened to retaliate with duties on $16 billion worth of US goods, including crude oil and refined products. All crude oil imports into China are currently exempt from tariffs, and a 25% tax will make any US-China arbitrage nearly impossible.
But it will open up opportunities for traders holding non-US crude, like Middle Eastern and West African grades, in their portfolio.
Hence, trade disputes also create opportunities — like a game of musical chairs — to redirect flows to mitigate the impact of disruptions, Craig Pirrong, professor of finance at the University of Houston, said.
“It is always a risk/reward sort of thing,” he added.
Source: PlattsPrevious Next