Glencore, Ltd. has been a fascination of mine for years. I first learned of their existence from Copetas' Metal Men and have tried to follow their actions in the media and within the industry since. They are viewed with a certain cult-like status in my eyes as the best of the best. The Maverick and Goose of international commodity trading. While I view their IPO as an unfortunate happenstance for their sake, I am ecstatic to have been given access to their prospectus.
Long-Term Global Market Correlations
A massive 1,637 page tome, their prospectus contains a wealth of information on strategy, risk and risk measurements, and the inner workings of the best arbitrage firm in the history of the world. That's correct, in the history of the world. Glencore's corporate grandfathers include firms like the Dutch East India Trading Company (VOC) and the English East India Company (EIC). Glencore is the quintessential case study in arbitrage techniques:
"Glencore focuses on maximising returns from the entire supply chain, taking into account its extensive global third party supply base, its logistics, risk management and working capital financing capabilities, extensive market insight, business optionality, its extensive customer base, strong market position and economies of scale."
"Glencore’s marketing activities source a diversified range of physical commodities from third party suppliers and from industrial assets in which Glencore has full or part ownership interests. These commodities are sold, often with valueadded services such as freight, insurance, financing and/or storage, to a broad range of consumers and industrial commodity endusers, with many of whom Glencore enjoys long-term commercial relationships."
Types of Arbitrage Strategies
"Many of the commodity markets in which Glencore operates are fragmented and periodically volatile. As a result, discrepancies generally arise in respect of the prices at which the commodities can be bought or sold in different forms, geographic locations or time periods, taking into account the numerous relevant pricing factors, including freight and product quality. These pricing discrepancies can present Glencore with arbitrage opportunities whereby Glencore is able to generate profit by sourcing, transporting, blending, storing or otherwise processing the relevant commodities. Whilst the strategies used by Glencore’s business segments to generate such margin vary from commodity to commodity, the main arbitrage strategies can be generally described as geographic-, product- and time-related." [Italics my own]
- "geographic: where Glencore leverages its relationships and production, processing and logistical capabilities in order to source physical commodities from one location and deliver them to another location where such commodities can command a higher price (net of transport and/or other transaction costs);
- product-related: where it is possible to exploit the blending or multi-use characteristics of the particular commodities being marketed, such as the various crude oil products, coal or concentrates, in order to supply products which attract higher prices than their base constituents, or exploit existing and/or expected price differentials; and
- time-related: where it is possible to exploit a difference between the price of a commodity to be delivered at a future date and the price of a commodity to be delivered immediately, where the available storage, financing and other related costs until the future date are less than the forward pricing difference."
Types of Marketing Activities
"Glencore’s marketing activities can be categorised in order of focus as follows:
Base supply chain activities: Glencore’s primary marketing activities are those performed in the ordinary course of its global sourcing and distribution of commodities, including the provision of multiple value added services across the full supply chain and seeking arbitrage opportunities (discussed above) as they frequently arise.
Event-driven activities: Glencore also seeks to optimise around an event or an anticipated event such as unexpectedly good or bad weather conditions, transport bottlenecks or failures (for example, a train derailment) or a labour or production issue as its global network alerts it to the possibility of such an event occurring or implications where such event has occurred. These types of events often cause global and/or regional ‘‘market tightness’’ (that is, a situation where available supply is insufficient to meet demand in a particular market) and Glencore’s marketing operations will often be able to derive enhanced returns from such market conditions. These situations are, of course, not predictable, but generally occur reasonably frequently during any particular year.
Price risk activities: Glencore also engages in some position taking within its marketing activities in which it applies its deep market intelligence and analysis to seek to profit from movements in the price and/or spread of a particular commodity, for example, by correctly anticipating a change in the price of a commodity and sourcing that commodity at a lower price than will be available later or selling that commodity at a higher price than will be available later. Glencore engages in price risk activities only in accordance with its risk policies and limits and price risk activities account for the substantial minority of Glencore’s overall marketing operations."
Logistics
"Glencore uses its global presence and ability to trade on several exchanges and geographical markets to exploit arbitrage opportunities between the various exchanges on which each of zinc, copper, lead, silver and gold are traded. This was particularly important in 2009 and 2010 when Asian markets led the recovery in commodity prices."
"Arbitrage opportunities are generally enhanced by global and regional price volatility and instability in the various commodities markets resulting in market disequilibrium. Glencore believes that, in periods where price components for a particular commodity or group of commodities display relative volatility and, therefore, uncertainty, the number of arbitrage opportunities in such commodities tends to increase, and, in particular, during periods of market tightness (e.g. when inventory levels are low). These market conditions offer additional opportunities to take advantage of the resulting decoupling in premium and discount structures. Conversely, in periods of reduced volatility in commodity prices, Glencore’s marketing business tends to have fewer profitable arbitrage opportunities. A relatively flat marketing environment generally reduces price dislocation and, in turn, the number of arbitrage opportunities." [Italics my own]
"Glencore’s marketing and industrial investment activities are supported by a global network of more than 50 offices located in more than 40 countries throughout Europe, North, Central and South America, the CIS, Asia, Australia, Africa and the Middle East. Glencore’s main offices are located in Baar (Switzerland), Stamford (Connecticut), London, Rotterdam, Beijing, Moscow and Singapore. This network provides Glencore with significant worldwide sourcing and distribution capabilities." "Glencore’s oil freight desk has a large and diversified fleet of 203 vessels as at 31 December 2010, operated under various short-term and long-term time charters and commercial management arrangements, with an average remaining fixed charge hire period of approximately three years at such date. In total, Glencore has equity interests in 41 vessels, which are delivered or currently under construction and are expected to be progressively delivered by March 2012. Glencore’s freight desk contributes to the marketing results of its business segments, providing immediate access to vessels, which can represent a significant time advantage in exploiting short-term marketing opportunities. Having its own freight desk also gives Glencore greater visibility over world trade flows at a particular moment. Due to its internal requirements and the Directors’ belief in Glencore’s ability to achieve vessel utilisation above average industry levels, Glencore generally has a long position in fleet time chartering, thereby creating a significant exposure to fluctuations in spot freight rates. However, given the nature of the freight market and limited opportunities to hedge all freight price risk, Glencore is generally exposed to some degree of future freight price movements on its long-term time charters, not otherwise subject to hedge, re-let with a third party or to satisfy its own marketing needs." [Italics my own]
Competitors
"Glencore’s main competitors are Vitol Group, Trafigura Group, Mercuria Energy and Gunvor, all of which are largely asset-light (little, if any, upstream production) business models. Glencore also faces marketing competition from banks such as Morgan Stanley and Goldman Sachs, which have some infrastructure and no current oil production, although the large majority of their business activities involve derivatives and not the physical sourcing and distribution of oil. Volumes captured by oil majors such as BP and Shell are also in direct competition with Glencore’s marketing volumes, although their participation in the market increases overall volume and liquidity."
Further Reading:
Commodity Price Volatility and World Market Integration since 1700Long-Term Global Market Correlations
