There are plenty of clichés to apply to commodities traders. One of the most applicable, given the profits these traders bring in when markets are in turmoil, is probably ‘when the going gets tough, the tough get going’.
These companies have chequered pasts, which include billions in fines and bribery convictions. Glencore (GLEN), Vitol and Trafigura say they have cut out the dirty tricks and that their businesses rely on honestly earned advantage and arbitrage. In any case, the big players are ready to cement their status in the energy and metals world as the energy transition sees demand and supply seesaw for oil, gas and metals such as copper and nickel.
Away from the specialists, BP (BP.) highlighted its trading division’s profit-making ability at last month’s capital markets day. That event produced talk that the oil major’s slimming down hasn’t gone far enough, but RBC Capital Markets analyst Biraj Borkhataria calls BP’s trading and optimisation business the “crown jewel” of its portfolio.
The world is clearly in serious need of their services, regardless of the margin that is handed over to these operators. “Uncertainty creates arbitrage options,” said Gary Nagle alongside Glencore’s 2024 results announcement in February.
BP’s trading boss, Carole Howle, put it in less stark terms at the company’s capital markets day when outlining what these companies actually do.
“[Trading is] leveraging the information that we’ve gathered across all of the customer flows and assets [ . . . ] and we use our extensive real-time market analytics to then formulate value trading or speculative positions,” she said.
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BP and Shell also trade electricity. This is a growing space as utilities try to balance intermittent power sources such as renewables, but the barriers to entry are lower and interest is high given forecasts about the needs of AI-powering data centres.
But the buccaneering spirit of the industry is focused on oil and gas, metals and minerals.
In these areas, BP, Glencore and Shell have three of the largest trading businesses in the world, so UK investors have more exposure on the equity side than just about any other set of shareholders.
Vitol, Gunvor and Trafigura are private companies, and information is far more limited on their activities. You would also need to get high up within their ranks to get a sniff at a stake.
The potential rewards for those high climbers are impressive: Vitol made profits of $13bn (£10bn) in 2023, according to various media outlets, and $15bn in 2022, when Russia’s invasion of Ukraine sent markets spinning. Reuters said Vitol bought back shares worth over $6bn from its employees in 2023.
That shows how concentrated the industry is – McKinsey thinks the trading industry as a whole raked in $100bn in operating profits in 2023, and around $70bn in 2024, earnings last year knocked by “increased pressure and higher competition”.
“Despite these recent developments, longer-term trends show trading value pools continuing to grow steadily through the end of the decade,” a recent report from the consultancy added.
Profits are set to remain at structurally higher levels, with the levels seen since 2022 far above the 2017-21 average of $38bn. These trends are linked to the energy transition, or rather the speed of the energy transition, and greater macroeconomic uncertainty.
The trading game
In their 2021 book The World for Sale, Bloomberg reporters Javier Blas and Jack Farchy said traders exist because the supply and demand of commodities “often don’t match”. It’s their job to get them to where the demand is, picking up a profit along the way.
This is not as simple as it seems, given the logistical challenges of moving large amounts of anything around the world. “Anything that is shipping, especially oil, LNG, as well as metals and minerals, is quite capital intensive,” says McKinsey partner and commodities expert Joscha Schabram.
Glencore has the most transparent operations in the sector thanks to the accounts it publishes for its marketing business (as it terms its trading unit).
Last year, adjusted Ebit was $3.2bn, at the top end of long-term guidance of between $2.2bn and $3.2bn. This is half what the traders achieved in 2022, but still well ahead of previous efforts.
In 2019, when oil prices were marooned between $50 and $60 a barrel, the company brought in $2.4bn in operating income through trading. This climbed another $1bn the year after thanks to the pandemic-triggered market disruption, but as metals and coal prices tumbled, the trading unit more than made up for it.
The majors
BP is tight-lipped about exactly how much it earns across its divisions from buying and selling commodities in paper and physical form, but said last month the business typically contributed 4 percentage points of group return on average capital employed (ROACE) over the past half-decade. ROACE overall has ranged from 13 per cent in 2021 to over 30 per cent in 2022.
The latter year was when oil and gas prices surged and traders had a field day. That provided a much higher than usual “uplift” to overall ROACE, as the company puts it.
The taciturn Murray Auchincloss, now chief executive but at the time chief financial officer of BP, described the first quarter of 2022 as a “double exceptional” period for trading profits.
Asked at the recent capital markets day just how trading fits with the other assets BP is retaining amid its current shake-up, Auchincloss said he would be giving up “commercial advantage” by saying anything other than that the business is split evenly between oil and gas.
In The World for Sale, Blas and Farchy said Shell and BP’s businesses handled around 10mn barrels of oil per day and made $2bn-$4bn a year in pre-tax profits each, with Shell aiming for the top end of that range annually. That 10mn bopd figure is far behind the amount that each produces.
This is unique among the peer group, which includes ExxonMobil (US:XOM) and Chevron (US:CVX): the two UK-listed giants are the only energy majors to be “competitive” with the trading specialists, Blas and Farchy note.
There had been talk of BP selling off much of its marketing business (distinct from trading, despite Glencore using the words as synonyms). This is the unit that sells refined products to businesses and consumers. Auchincloss said in February that doing this would “completely destroy and damage trading”.
HSBC analyst Kim Fustier points out that this conclusion isn’t always recognised outside the business. “Trading’s contribution to earnings is well understood, but its role in portfolio management less so . . . BP said it will avoid divesting highly integrated businesses, an angle often overlooked by external observers,” she says.
Despite management limiting commentary on trading to terms such as ‘exceptional’, ‘weak’ or ‘strong’, Borkhataria has estimated how much of BP’s earnings come at least partly from making bets on the price of oil and gas. He puts 2022 earnings at around $6.5bn, while 2024’s was around $3.5bn. “Based on these [assumptions], BP’s trading division would have generated around 40 per cent of group earnings in 2024, further reinforcing our view that a break-up is likely to destroy more value than it creates,” he says.
Shell has also talked up the integrated nature of its trading business. “Our trading capability allows us to be able to really sort of draw on third-party supplies, but that needs to be underpinned with our own supply,” said chief executive Wael Sawan last month.
So what next?
If 2024 was a low volatility year, then 2025 should push up trading profits as US President Donald Trump introduces a range of import levies. “Long term, these sort of tariffs may not be so good for global growth; in the short term, we see this volatility and this heightened uncertainty [as boosting] our ability to get better returns [from] our marketing business because of these dislocations and arbitrage opportunities,” says Nagle at Glencore.
Why then won’t more companies move into trading? Schabram from McKinsey notes that there are a few barriers to entry that meant Glencore and co would likely stay at the top. First is access to serious amounts of cash, for both the initial purchasing of commodities to be sold on and then any potential headaches along the way, such as margin calls.
These are payments made to lenders when the price of a commodity has shifted. For example, if you have borrowed $100mn to spend on a shipment of nickel, and the price of the metal drops, then the loan is no longer fully secured. “Margin calls are a mechanism to protect brokers from losses that might occur when investors borrow to invest and markets move against them, potentially leading to a situation where the debt owed exceeds the value of the borrowed securities,” says Gunvor, another private trading house.
Another barrier to entry, Schabram says, is getting the right talent.
Building a serious trading unit within a public company like BP, Shell or even Rio Tinto (RIO) or BHP (BHP) is a challenge because good traders want to make serious money. “An advantage of the merchant traders is that they have equity in the hand of the management,” he says.
BHP has its own trading subsidiary (Swiss-registered, of course), but Nagle at Glencore has dismissed the prospect of any one rivalling his company.
“Many competitors have tried to replicate what we do and can’t,” he said last month, when asked if the trading business could be hived off to allow a major merger to happen. “It’s a very unique skill that we own and would be an attraction if there was some sort of transaction to be done.”