Commodity traders: The trillion dollar club

[scandal 951]

Long, but a good read.

Commodity traders: The trillion dollar club

On Friday October 21, 2011, 12:36 pm

By Joshua Schneyer

NEW YORK (Reuters)- For the small club of companies who trade the food, fuels and metals that keep the world running, the last decade has been sensational. Driven by the rise of Brazil, China, India and other fast-growing economies, the global commodities boom has turbocharged profits at the world's biggest trading houses.

They form an exclusive group, whose loosely regulated members are often based in such tax havens as Switzerland. Together, they are worth over a trillion dollars in annual revenue and control more than half the world's freely traded commodities. The top five piled up $629 billion in revenues last year, just below the global top five financial companies and more than the combined sales of leading players in tech or telecoms. Many amass speculative positions worth billions in raw goods, or hoard commodities in warehouses and super-tankers during periods of tight supply.

U.S. and European regulators are cracking down on big banks and hedge funds that speculate in raw goods, but trading firms remain largely untouched. Many are unlisted or family run, and because they trade physical goods are largely impervious to financial regulators. Outside the commodities business, many of these quiet giants who broker the world's basic goods are little known.

Their reach is expanding. Big trading firms now own a growing number of the mines that produce many of our commodities, the ships and pipelines that carry them, and the warehouses, silos and ports where they are stored. With their connections and inside knowledge -- commodities markets are mostly free of insider-trading restrictions -- trading houses have become power brokers, especially in fast-developing Asia, Latin America and Africa. They are part of the food chain, yet help shape it, and the personal rewards can be huge. "The payout percentage of profits at the commodities houses can be double what Wall Street banks pay," says George Stein of New York headhunting firm Commodity Talent.

Switzerland-based Glencore, whose initial public offering (IPO) in May put trading houses in the spotlight, pays some traders yearly bonuses in the tens of millions. On paper, the partial float made boss Ivan Glasenberg $10 billion richer overnight.

SIZE MATTERS

How big are the biggest trading houses? Put it this way: two of them, Vitol and Trafigura, sold a combined 8.1 million barrels a day of oil last year. That's equal to the combined oil exports of Saudi Arabia and Venezuela.

Or this: Glencore in 2010 controlled 55 percent of the world's traded zinc market, and 36 percent of that for copper.

Or this: publicity-shy Vitol's sales of $195 billion in 2010 were twice those at Apple Inc. As well as the 200 tankers it has at sea, Vitol owns storage tanks on five continents.

U.S. regulations are now pending to limit banks' proprietary trading -- speculating with their own cash. The new rules don't apply to trading firms. "Trading houses have huge volumes of proprietary trading. In some cases it makes up 60-80 percent of what they do," said Carl Holland, a former price risk manager at oil major Chevron Texaco, who now runs energy consultancy Trading Solutions LLC in Connecticut. "They have the most talent, the deepest pockets, and the best risk management."

In addition to proprietary trading curbs, the U.S. regulator voted on October 19 to impose position limits in oil and metals markets. That gives banks who trade futures cause for concern, but since physical players usually receive exemptions to limits -- because they are categorized as bona fide hedgers -- trading firms should go unscathed.

The trading houses' talent and deep pockets translate into incredible power. "Most commodity buyers in the world are price takers. The top trading firms are price makers," said Chris Hinde, editor of London-based Mining Journal. "It puts them in a tremendous position."

The sort of position that has allowed Vitol to do a brisk oil business with the U.S. government, the besieged Syrian regime, and Libya's newly empowered rebels simultaneously over the past few months. In April the company dodged NATO bombs and a naval blockade and sent an oil tanker into the battered Mediterranean port of Tobruk to extract the first cargo of premium crude sold by rebels at the helm of a breakaway Libyan oil company defying Muammar Gaddafi.

Vitol also discreetly supplied Libya's rebels with $1 billion in fuel, Reuters has learned -- supplies they desperately needed to advance on Tripoli. Vitol's early running gave the firm an edge with the country's new political stewards. As it turns the pumps back on, Libyan oil firm Agoco has allocated Vitol half of its crude production to repay debts.

While its savvy traders were doing deals in eastern Libya, Vitol, along with rival Trafigura, kept refined product supplies flowing to the besieged government of Bashar al-Assad in Syria as his troops attacked civilians. Trading houses were able to do this because international sanctions on Syria do not ban the sale of fuel into the country, but they did not have to fight off much competition for that business.

PAST SCRUTINY

Despite a relative lack of regulatory oversight, such reach does attract scrutiny. "There has always been some concern about the trading firms' influence," said Craig Pirrong, a finance professor and commodities specialist at the University of Houston, who points out that some firms "have been associated with allegations of market manipulation".

Public and regulatory attention usually rises with prices. A spike in world food prices in 2007 stirred an outcry against the largest grain trading firms; when oil prices surged to a record $147 a barrel in 2008, U.S. Congress probed the role of oil trading firms, but found no smoking gun. But in May the U.S. Commodity Futures Trading Commission sued Arcadia and Parnon, both owned by a Norwegian shipping billionaire, for allegedly manipulating U.S. oil prices three years ago, amassing millions of barrels they had no intention of using. The companies dispute the charges.

Some transgressions make headlines. Switzerland-based Trafigura was caught shipping sanctioned Iraqi crude in 2001, and in 2006 a tanker it chartered dumped toxic waste in Ivory Coast, allegedly making thousands ill and killing up to 16. Courts did not find any connection between its waste and sick people. But after unsuccessfully suing to keep a British parliamentary probe out of the newspapers, Trafigura paid $200 million in compensation.

And it's not just the Europeans. Executives of Illinois-based ADM, formerly Archer Daniels Midland, were jailed for an early 1990s international price-fixing conspiracy for animal feed additive lysine. After Minnesota-based Cargill built a huge soybean terminal on the banks of the Amazon River in 2003, it was targeted by Greenpeace and subjected to Brazilian government injunctions for allegedly encouraging more farming in fragile rainforest. Cargill has since placed a moratorium on buying soybeans from newly deforested land.

THE SQUEEZE AND THE ARB

For many commodities traders, the most profitable ploy has been the squeeze, which involves driving prices up or down by accumulating a dominant position. In the early 2000s, the Brent crude oil stream -- used as a global price benchmark -- fell to 400,000 barrels per day from more than 1 million in the late 1980s. A few traders seized the chance to buy what amounted to almost all the available supply. Price premiums for immediate supply spiked, sapping margins for refiners worldwide. U.S. refiner Tosco sued Arcadia and Glencore for market manipulation; the case was settled out of court.

In metals, stock in warehouses can be tied up for years as loan collateral, allowing the same traders who dominate the metals market to control a huge chunk of world supply -- an apparent conflict of interest that has drawn criticism from the UK parliament.

"The warehouses seem to have an infinite capacity to absorb metal, but a very small capacity to release it," said Nick Madden of Novelis, the world's top rolled aluminum producer.

Trading houses saw the opportunity to leverage metals warehousing after the 2008 financial crisis. Of the six major metals warehousers only one, Dutch-based C.Steinweg, remains independent. Trading houses competed with banks for the spoils -- Glencore, Trafigura and Noble took one warehousing company each, Goldman and JP Morgan the others.

And unlike commodities producers, such as U.S. oil giant Exxon Mobil, trading firms don't just make money when prices go up. Most rely on arbitrage -- playing the divergence in prices at different locations, between different future delivery dates, or between a commodity's quality in different places.

That's what Koch, Vitol and others did in 2009 when they parked 100 million barrels of oil in seaborne tankers. Thanks to a market condition known as contango -- a period when buyers pay more for future delivery than to receive their cargoes promptly -- they could sell futures and lock in profits of $10 a barrel or more.

RICH HISTORY

Many of the biggest players in oil and metals trading trace their roots back to notorious trader Marc Rich, whose triumph in the 1960s and 70s was to create a spot market for oil, wresting business away from the majors.

Belgium-born Rich joined Philipp Brothers, subsequently Phibro, aged 20, leaving in 1974 with a fellow graduate of the Phibro mailroom, Pincus "Pinky" Green, to set up Marc Rich and Co AG in Switzerland.

Rich, now 76, would later end up on the FBI's most-wanted list for alleged tax evasion and trading oil from Iran after the revolution in 1979. He was later pardoned. His partners seized control of the firm in 1994, renaming it Glencore.

Several big trading houses are still family-held -- firms like agricultural giant Cargill, the top private U.S. company, or Kansas-based Koch Industries, a close No. 2. Koch's chief executive Charles Koch, a libertarian activist with a $22 billion personal fortune according to Forbes, has said his company would go public "over my dead body". "The thinking is, why open the books to the world?" said a former lobbyist for Koch who requested anonymity. "Koch benefits from privacy, and it's astonishingly agile and profitable as is."

The old guard now faces a challenge from a new breed of Asian competitors. Companies like Hong Kong-based Noble and Singapore's Olam and Hin Leong are not new, but they are spreading their wings as China's influence in commodities markets increases. Chinese state funds have flowed into Noble and private Asian traders. As China's clout grows, it's very likely that Chinese firms will build trading dynasties of their own. In a move borrowed from the playbooks of western rivals, state-run oil firm PetroChina has set up a Houston oil trading desk and leased massive oil storage tanks in the Caribbean. "China is becoming more like a Glencore," said Hinde. "The Chinese state is funding nimble trading firms to do its bidding. We don't hear much about them yet, but in time we will."

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The consumer has been getting hosed by this for decades.