Commodities are once more in the spotlight and some call for a new commodity supercycle, so I thought it was an opportune time reading the book. Better late than never.
The World for Sale by Javier Blas & Jack Farchy: Blas is an energy and commodities columnist at Bloomberg. Your can follow Javier Blas on Twitter here.
If you prefer to read the pdf version click here. (links may not work in pdf)
(as in my previous book review I focus more on my learnings/insights/personal summary vs writing style etc.)
Connections and personal relationships are important in the commodity trading industry. I believed so before starting the book and was instantly assured thereof. But, when I was 10% through the book I read a piece worth sharing: At metals trader Transamime (…) a trader is more likely to be fired for taking a contact out for a bad lunch that for losing money on a trade.
- This highlights the importance of personal relationships, and the risk of losing key personelle.
Key personnel is the main asset. This is true for commodity trading houses just as it is for investment banks. And these assets walk out of the office every single evening. As the departure of Marc Rich from Phillips Brothers highlights, there is a real risk of losing these assets if they are not paid enough. But what is enough? For very successful, that means profitable, traders it come naturally to ask for higher pay. If the demands are not matched, they might leave and strike out on their own, just as Marc Rich did, founding Marc Rich and Co, with several other defectors from Philipps Brothers.
- Worse, even unskilled traders might ask for a pay rise on the basis of very profitable trades (that might purely come from luck).
A lesson on (un)profitable trades. A great lesson on contracts and that one only knows if and how profitable a concluded contract is afterwards. In the 1970s Russia bought grains from the US and each trading house thought it had locked in a great trade, before realizing Russia had bought from every single trading house and there would not be enough US grains. The trading houses did sell grains they did not (yet) own, and lost a lot of money on the trades.
- Some traders realized afterwards, what had happened, gathered more information to gain an edge and made a killing betting (speculating) on price developments, via futures.
Commissions were always a part of doing business in far flung parts of the world. One of the most profitable trades was to get a handle on a long-term supply contract at official oil prices and sell it for 5 or 10 dollars more per barrel at spot prices. Getting such a lucrative supply contract of course required commissions, that were very small in relation to the trades total profit.
- Whereas the US had introduced anti corruption laws, the EU hadn’t, and in switzerland it was possible to use such paid bribes (or facilitation fees for access) as tax-deductibles.
The importance and power of commodity traders grew enourmusly over time. Comodity traders might be a-political (and only care for profits) but they certainly shape and even write history. Especially so when dealing with states and governments, shun by most actors.
Deception and disguise enable the most profitable trades. A JV with states that were able to buy oil at discounts from friendly states (on political reasons) delivered outrageous profits.
Regime change can alter industries and profitable strategies. The physical commodity traders’ business dynamics and opportunities for profits was changed when the industry was financialised (futures, derivatives) with ‘paper barrels’. Well capitalized financial players traded oil without ever seeing or handling physical commodities, neither did they fly to far flung places wining and dining with (shady) politicians and beauroucrats. The upheaval brought by the dissolution of the USSR also brought enourmous change in the industry and tremendous profit opportunity if you made valuable contacts for getting your hand on very cheap USSR supplies and contracts.
- I could not help but to think about scenes from Lord of War (video)
- Regime change in financial markets (think rising rates) could bring similar changes
Shell and BP built respectable oil trading units competing with trading houses, and trading many more barrels per day than they produce. At least one of them used trading algorithms as early as 1990.
Betting on commodity prices and trends broke some commodity traders and made others.
- The rise of China preset a decades long trend of rising commodity prices (8). A country’s commodity consumption mostly depends on two factors in a non-linear relation: the number of inhabitants and their income. Commodity demand rises fastest above per capita income of $4k until reaching 20k.
Value of optionality. Betting on prices was much easier now with futures but their was another profit driver at play. Until the 2000s the value of optionality was little understood by market participants other than traders and not much attention was paid to it. Optionality allowed traders to buy/sell a slightly higher/lower amount than agreed on in the contract. During periods of flat prices, this is not an important feature but turing periods of rising prices due to China, this optionality became a license to print money.
- During my studies I delved on the subject of embedded options in fianncial retail products. Viewed that way, the potentially significant value of this optionality becomes instantly apparent.
Commodity traders are blamed for high food prices and negative effects of high commodity prices or their high Volatility. Serious research mostly concludes that strong evidence is missing, though.
- What would be easier for politicians? Who gets the blame for the energy crisis today? The true reasons are certainly multifaceted but one thing is almost certain: our politicians are not at fault!
Glencore’s IPO brought the industry into the spotlight. The media and business partners got notice of business and profit volumes that were once hidden and kept a secret. Another lifted secret:
- The day when Glencore’s IPO prospectus became public, the world — incl. the companies own traders except for three employees — got to know who owned Glencore.
- The IPO minted billionaires and an army of millionaires.
Opportunity and risk often went hand in hand when commodit traders were right on the edge legally and morally, doing business with states and persons sanctioned by states and avoided by most businesses.
- When the US started to use the USD system as a tool for its foreign policy enforcement commodity traders felt the heat
- For example, BNP Paribas, Trafiguras main financier, had to pay a record amount, even if Trafigura did nothing illegal (or so the evaluation read)
Their informational edge was one factor to enable the commodity traders to realize outsized profits, often merely using price differentials in two places. When information became much more available (also via Bloomberg, its founder a former trader) their informational edge and their profit pools shrank. Further, regulation, legal and ethical rules limit their opportunity. Still, they are an important part in a globalized world.
- A less globalized world, might shrink their trading volumes and profit opportunity.
- Information is still very important, they learned early about corona developments in China from on-the-ground contacts
- When oil was given away for free in early 2020, commodity traders were able to size the opportunity and earn outsized profits once more. They hired fleets of tankers turning htem into floating storages in a time with scarce storing capacity, loaded the cheap oil (spot), sold mor eexpensive futures (few months fwd), and made 50% profits and more, even after accounting for shiping costs.
What i did not like:
- The structure of the book could have been better IMO, maybe more and smaller chapters.
- Often, I read the same content a few times, and certainly a few times more than I deem optimal
(readers of Howard Marks know about reading the same content/statements more than once but I felt it was more of a good/beneficial balance)
What i liked:
- Great read about the history of commodity trading houses
- Industry insights
Links: for the interested
- Copper tightness (bbg)
- Undervalued Shares revisists a copper treasure hard to lift.
- Glencore recently trades above IPO price
- Glencore suspended daily VaR limits to cash on Volatility after Russian invasion (tweet)
(BBG May 17, 2022) Russia appears to be overcoming the retreat of top oil traders as several smaller firms get more active in handling the country’s barrels. Geneva-based Litasco has become the largest handler of Urals after booking tankers to haul at least 14 million barrels in April, and 8.6 million already this month. Bellatrix, a name previously unheard of, is also moving supply. Read more on the firms and their activities.