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14 October 2014 By Swaha Pattanaik

Commodity producers and traders were once very different beasts. But the distinctions between the two are increasingly fuzzy.

Glencore’s recent attempt at a $160 billion merger with mining giant Rio Tinto was the latest move by the world’s biggest commodity trader to secure more supply that could be pushed through its marketing arm. Meanwhile, companies that traditionally focused on exploration and production are increasingly seeking to market what they produce. That’s why oil giants such as BP have sizeable trading operations, and why the likes of BHP Billiton and Anglo American are increasingly trying to exploit similar opportunities in mining.

The commodity trading market could grow by about 40 percent as producers become more active traders, says consulting firm Oliver Wyman. That’s in spite of regulatory pressure forcing investment banks to exit the business. However, the corollary of increased trading activity is slimmer trading margins.

Thermal coal trading margins have shrunk by two-fifths over the past five years as the commodity has become more widely traded with transparent price benchmarks, Oliver Wyman estimates. The consultancy reckons that if the pattern recurs in the liquefied natural gas or the metals and minerals markets, traders’ margins could fall from 30 percent and 5 percent respectively to something approaching the 0.5-1 percent prevalent in the oil market – although the timeframe is not specified.

Combine this with the growing difficulty that traders face in obtaining long-term contracts, and it is little wonder that the independent trading houses are increasingly interested in buying hard assets to secure supply. Glencore has gone so far down this road that producing commodities is now the bulk of its business. Others, such as Trafigura, are investing in infrastructure to support their trading business, though they still own relatively few assets.

With margins set to shrink, the key to success, or even just survival, in the commodity market will be to trade large volumes. This will favour either giant diversified firms or very niche specialists who can dominate trading in their chosen commodities. Whether these are producers or traders may become hard to tell.

 

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