What the new order in commodity trading means for buyers

Developments in commodity trading have the potential to spark market disruptions and higher commodity price volatility according to a report from Oliver Wyman. The report “The Dawn of a New Order in Commodity Trading – Act III” highlights the risk that changes in the commodity trading environment could have for both producers and consumers of commodities as well as an opportunity for investors.

Virtually all agricultural, energy, and industrial commodities must undergo a variety of processes to transform them into things that we can actually consume. These transformations can generally be grouped into the following categories; space, time and form. Firms that are involved in commodity trading attempt to identify the most valuable of these transformations, undertake the transactions necessary to make these transformations and engage in the physical and operational actions necessary to carry them out.

This process has a number of benefits for consumers, mainly smoothing out supply and demand imbalances that could otherwise cause a supply disruption or increased commodity price volatility. To illustrate their importance for commodity supply chains the leading independent energy trading houses – Vitol, Glencore, Trafigura, Mercuria and Gunvor together handle more than enough oil to meet the import needs of the US, China and Japan. Agriculture is similar with ADM, Bunge, Cargill and Dreyfus thought to handle about half of the world’s grain and soybeans trade flows while Glencore and Trafigura controls as much as 60% of some markets, such as zinc.

Related article: Geopolitics and oil price volatility

However, the report notes a number of trends which if they coincide could introduce more uncertainty into many commodity markets and increase the risk of disruption. Commodity markets are maturing and becoming more efficient reducing the margins available to intermediaries. Taken together with the exit of many of the worlds largest Western investment banks from commodity trading has meant that commodity trading is likely to become more homogenous. Companies will only operate in those markets where they can create significant value from their existing positions, e.g. large commodity producers, such as oil majors and national oil companies, are increasingly establishing trading activities so that they can monetize their upstream production and gain greater control over their value chains.

In order to compete in this new world many of the independent traders have been loading up on debt to secure physical assets. This has caught the attention of rating agencies and increased their cost of capital, reducing the incentive for them to make volumes of inventory readily available to head off supply disruptions. Traders are also abandoning some markets or reducing their activities, resulting in less available liquidity for hedging products. Ultimately this could mean that commodity prices will be more vulnerable to sudden disruptions than they have been and fewer tools available for businesses to help manage the risk of disruption and volatile prices.

Related article: Is food price volatility about to return with a vengeance?

Crunch time for European gas supplies?

Talks between Russia, Ukraine and the European Union are due to restart today (26 September) hoping to reach a deal over Ukraine’s unpaid gas bill that could lead to a resumption of Russian gas supplies to Ukraine. Gazprom stopped shipping gas there in June. This comes as a number of Central European countries report gas flows from Russia 20%-25% below contracted levels in recent weeks. Slovakia, Poland and to a lesser extent Hungary have been redirecting gas to Ukraine. In response to this Russian energy minister Alexander Novak has reportedly threatened further gas supply disruptions if the EU continues to re-export Russian gas to Ukraine. Day-ahead gas prices have risen by 20% over the past month to almost £0.50 per therm on fears of disruption.

According to Reuters the EU is going to propose a one off purchase of Russian gas to cover the peak-demand winter season to April 2015 and hopefully avert the EU’s gas supplies being cut off. Ukraine needs 5 billion to 20 billion cubic metres (bcm) of extra gas, depending on how cold the weather is, to get through winter without supply disruptions. However whether a deal can be struck depends on Russia. Societe Generale has warned that in the event of a supply disruption subsequent spikes in gas prices may take longer to abate as the market distrusts there will be a lasting solution to the Ukraine crisis.

Europe appears relatively safe from disruption at the moment. According to Gas Infrastructure Europe gas storage facilities across Europe contain a record 75.7 billion cubic meters, making them more than 91 percent full. So in the event of a disruption there would be time to find alternatives. However, some countries are more vulnerable than others particular Bulgaria, Finland and the Baltic countries. Meanwhile another cold winter will mean that stocks are used up more rapidly.

Light my fire (2152952690).jpg
Light my fire (2152952690)” by Michal Osmenda from Brussels, Belgium – Light my fire
Uploaded by russavia. Licensed under CC BY-SA 2.0 via Wikimedia Commons.

Norway, a big producer and the second largest gas supplier to Europe could pump a little bit more. Although costly a slowdown in China the reopening of some nuclear plants in Japan will mean more liquefied natural gas (LNG) is available on spot markets. Europe has the capacity to import more than 200 bcm of LNG a year, of which just 20% is in use. Meanwhile contingency plans are reportedly being drawn up by the EU which might include cutting gas to industry to preserve supplies for heating homes and generating power.

Longer term Iran could be a potential alternative source of gas for the EU (it has the world’s second largest gas reserves after Russia) but at the very least this is several years away. According to an EU report, “High potential for gas production, domestic energy sector reforms that are underway, and ongoing normalization of its relationship with the West make Iran a credible alternative to Russia.” However there is considerable doubt as to whether a deal can be arranged over its nuclear capability that could then lead to the lifting of sanctions. The deadline for a deal is 24 November.

Related article: Risk of disruption to European gas supplies put at 30%

Related article: Europe has little to fear as Ukraine prepares for gas cut off

What happened to the nickel price boom?

After Indonesia introduced an export ban on nickel ore in mid-January, nickel prices promptly surged by over 50% reaching a high of just over £21,000 per tonne in mid-May. Prices were also buoyed by geopolitical concerns elsewhere, namely the risk of sanctions on the worlds biggest nickel producer, the Russian company Norilsk Nickel. Investor interest measured by open interest on the LME (the total number of options and/or futures contracts that are not closed or delivered on a particular day) rose by over 60% from the start of 2014.

Shortly after the market started to cool, Citibank issued a report forecasting that nickel prices would continue to rise by another 50%, rising to over $30,000 per tonne in 2015. They did note however that further corrections may come in the coming months as North America and Europe wind back stainless steel production (around three-quarters of global nickel supply is used in stainless steel and super alloys).

Indeed prices continued to trade around $19,000 per tonne until early September, before briefly rallying to $20,000 per tonne on the possibility that the Philippines would follow Indonesia’s lead and introduce its own unprocessed ore export ban. This was dismissed as unlikely and in any event years away from being introduced. Since then nickel prices have dropped sharply, retreating back to $17,000 per tonne. One of the key factors behind the aborted price surge has been the apparent lack of a shortage in the market reflected by ongoing increases in LME nickel stocks as well as recent concerns about slowing Chinese demand, reflected in weak base metal prices generally.

Back in January Materials Risk highlighted three risks that could derail a nickel price boom – political uncertainty in Indonesia, a supply response and finally the impact of nickels main consumer, China. Elections in Indonesia came and went during April and July with only a slight hint of a change in policy but essentially business as usual.

Production of processed nickel pig iron in Indonesia meanwhile (the whole point behind the export ban) is starting to increase, albeit still at a low level. China’s Tsingshan Group the latest of a handful of companies that have either started or close to opening up a nickel pig iron smelter soon.

Finally, there were suggestions at the start of the year that Chinese consumers had front-run the potential ban by stockpiling substantial amounts of nickel ore to see out any supply outage for at least 6-9 months. Chinese producers are now blending Indonesian and lower grade Philippine ore in order to extend nickel production. The apparent economic slowdown to hit China is likely to mean that supplies may last longer than initially expected but they clearly can’t last forever.

Related article: The commodity most affected by El Niño is…Nickel

Where do nickel prices go from here? According to Goldman Sachs $17,000 per tonne may be the floor for nickel prices as a result of slowing stockpile gains, refined metal trading at a discount to nickel pig iron and squeezed nickel pig iron (NPI) margins, the bank forecasting that nickel will trade at $22,000 per tonne over the next 6 to 12 months. Macquarie meanwhile expects nickel prices to trade between $22,000 and $25,000 per tonne in 2015. Overall consensus price forecasts see nickel prices seeing further strong price increases of 30%-40% over the next 3-4 years.