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?

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