What do we know about the trillion dollar club? Understanding the economic geography of commodity trade

By Wouter Jacobs and Thomas van Bergen*

Commodity traders are crucial in managing global supply chains. It is linked with the financial sector on the one hand and with production, storage and distribution on the other. The industry is dominated by a few extremely large firms: the top five of firms, sometimes referred to as the the trillion dollar club, generated more than € 450 billion in revenues last year, just below the top five of financial companies, but more than the combined sales of leading players in technology or telecom. Despite the sheer size of the industry, little is known about how these commodity traders manage the complex information and commodity flows, and, of course, where these activities take place. Access to and control over increasingly scarce commodities and contested supply routes are becoming more and more a geopolitical concern, so more understanding about the functioning of this industry is needed.

What is Commodity Trade?
Commodity trade is an investment strategy wherein goods (raw materials, production inputs) are traded instead of stocks. Commodities traded are often goods of value, consistent in quality and produced in large volumes by different suppliers such as wheat, coffee, sugar, oil, ore and non-ferrous metals. The role of the commodity trader is to match supply with distant demand and negotiate a premium. In essence, the competitive advantage (the capacity to negotiate a premium) of the commodity trader is based upon its knowledge of and information on supplies, demand, quality, prices and risks. These factors differ geographically. In order to take full advantage of these geographical difference, traders need to understand complex financial-economic instruments while at the same time need to carefully manage global logistics to ship the commodities on the right time to the market. This is what consultant Oliver Wyman calls ‘optionality’: “the ability to pay producers more than end users while selling more cheaply to end users than producers can afford”.

Who are the Commodity Traders?
There are two types of commodity traders. Firstly the ‘paper’ traders, those who speculate on price fluctuations without necessarily taking physical control of the commodities. They are typically banks, hedge funds and institutional investors such as pension funds or sovereign wealth funds. Secondly, there are the commodity houses who actually have physical ownership of the commodities and are responsible of shipping them to markets. This distinction is somewhat artificial as some banks, most notably Goldman Sachs and BNP Paribas, do actually own physical assets, while all the large commodity houses engage in paper trade to mitigate risks in price fluctuations, the so called futures trade. This trade in futures actually has an indirect effect on ports. When future prices are higher than current ones, ‘contango’ the traders have all the incentives to store their commodities in tanks or warehouses that are often located in ports. Yet, when the futures price is lower than the current price, then the traders want to sell as quickly as possible and secure margins.
The large commodity houses that have actual physical control over the commodities are relatively unknown to the public. They have been dubbed by press agency Reuters as the trillion dollar club due to their large turnovers. Within argi-bulk related commodities the largest traders are referred to as the ABCD, which stands for the American companies ArcherDanielsMidland, Bunge Limited, Cargill and French-based Louis Dreyfus. In the oil and energy related business the biggest traders are Vitol,  GlencoreXstrata, Trafigura, Gunvor, Mercuria and Koch Industries. In addition to these pure trading groups, some large producers mainly in the oil business such as Shell, BP and Total have also their own trading desks. And there are new global entrants, mainly from Asia and Russia. For example, Russian oil producer Rosneft recently took over the entire oil trading desk of the American bank Morgan Stanley.

How is commodity trade conducted?
Commodities are traded through spot markets and on commodity exchanges. The largest commodity exchanges are the Chicago Mercantile Exchange (CME), New York Mercantile Exchange (NYMEX) and the Intercontinental Exchange (ICE, the former International Petroleum Exchange based in London). There also specialized exchanges such as the London Metals Exchange (LME) and London International Futures and Financial Options  Exchange (LIFFE). The exchanges used to be places where the traders met face-to-face to buy and sell within so-called calling pits. During the mid-1990s, however, these exchanged have become fully digitized allowing the trade to be conducted from more or less anywhere as long as one has access to the internet. More recently there has been a process of merger and acquisitions. The most spectacular of these is the purchase of the NYSE- Euronext stock exchange by the ICE in 2012. Other recent examples are the takeover of the LME by the Hong Kong Exchange and of the NYMEX by the CME.

The exchanges thus provide platforms for traders to transact and in such a way prices are set. In addition, the commodity exchange also registers storage facilities, mostly located in ports. The exchanges can also delist certain warehouses from their registers, effectively banning them from the market. An effect that can have serious consequences. For example in 2012 the LME issued a ban on copper sheds in the Dutch port of Vlissingen, largely owned by Glencore’s Pacorini Metals warehousing division. The effect of that ban is that copper now moved to the port of Antwerp, stored at sheds largely controlled by Trafigura’s NEMS metal storage division. Up to 2013, Antwerp accounted for 87% of all copper inventory stored at LME approved storage facilities in Europe according to Reuters.

From where is commodity trade conducted?
Due to digitization of the exchanges, there is no need for the traders to have an actual physical presence nearby the exchange building. And while most of the traders have a physical presence in ports to operationally handle the flows of commodities, their trading desks are often located far away. Nonetheless, the traders still cluster geographically in only a few places that can offer a combination of location factors, of which skilled labor and a business friendly tax climate are the most important. Due to its financial complexity, traders tend to locate their trading desk in financial centres, typically London. Geneva in Switzerland with its favorable tax climate has however overtaken London’s dominant role as many global traders have located their head offices and trading desks there. Geneva currently arranges approximately 50% of global trade in coffee, 50% of sugar, 35% of oil and 35% of cereals/rice. It is from these offices in landlocked Switzerland where not only the trades are made and financed, but also from were the logistics is being arranged. Of course there are still some places that for historical reasons have managed to secure some trading activities such as grain in Rotterdam, coffee in Hamburg and cacao in Amsterdam. And new trading places are emerging where demand is growing, in particular Singapore has been developing into Asia’s leading hub for commodity trade.

Moving down the supply chain
Commodity traders have been actively building up assets over the last years. Due to the importance of logistics, inventory management and the need to anticipate fluctuations in prices and global demand, the commodity traders have started to integrate vertically. For example Vitol set up its own tank storage division in 2006, VTTI, in partnership with the Malaysian shipping company MISC. VTTI currently has tank storage facilities in 11 ports across the globe, including the Eurotank facilities in  the ports of Amsterdam, Rotterdam and Antwerp (the so called ARA region). In addition, Vitol also owns its own tanker company Mansell, it has its own captive insurance group Anchor and in 2011 acquired almost the entire downstream division of Shell in Africa. Through the merger with global mining company Xstrata in a deal worth 80 billion dollars, the Swiss trader Glencore also moved down the chain and effectively secured its global minerals supplies. That same year Glencore also took over the Canadian grain trading company Vittera, including its elevator assets in a deal worth 6.1 billion dollar. Glencore now controls of half of Canada’s total grain exports. By moving down the supply chain, the so-called pipeline strategy, the traders can generate profits at various points in the chain and reduce uncertainty.

The trading houses have taken full advantage of high commodity prices the last decade  by acquiring strategic assets along the supply chain even though the global bonanza has somewhat slowed down in recent years. However, there are some other structural changes that will change the landscape for the years to come. Oliver Wyman talks about a ‘shake out’ while McKinsey speaks of ‘strategic crossroads’.  First of all, competition is increasing as new players are entering the global market. These new entrants come from resource rich developing countries and are quickly setting up their own trading desks to market their products. The margins of the traders are also put under pressure due to the lack of financial capital to further expand and acquire assets. New financial regulations set in place after the 2008 global financial meltdown have constrained the ability of banks to finance transactions with commodities as collaterals. Therefore it is expected that some middle sized traders will not survive the coming years and that a new round of mergers and acquisitions will take place.

* This blog is based on an article published in Port Technology International (2014). Wouter Jacobs is a senior research fellow at the Institute of Transport and Maritime Management Antwerp (ITMMA) at Antwerp University. Thomas van Bergen is junior researcher at the same institute.