By Archie Hunter (Bloomberg) —
Higher interest rates are forcing commodity traders to reconsider some trades and driving up prices. This is the latest example of how a period of rapid central bank rate hikes is reshaping global business.
The companies that buy, sell, and transport the world’s natural resources are particularly vulnerable to rising interest rates because they rely on bank lines to fund their operations — from shipping a shipment of wheat or oil to holding inventories of aluminum.
As rates rise, the added expense of weeks of travel or prolonged storage in a warehouse or tanker makes certain professions far less attractive. The cost of financing can determine whether or not business is done, and some companies try to pass the cost on to their customers, or pull out of some businesses entirely.
“It’s completely changing the supply chain, we have customers who come to us and say they need to rethink their business models because of interest rates,” said Pierre Galtié, head of commodity trade finance at Banque de Commerce et de Placements, in one Interview . “Players could buy a large cargo and store it for a month or more at a manageable cost. It’s a bit different now, the carry cost is much higher and not an option,” he said.
The pressure on commodity traders is an example of how the end of the easy money era is changing the face of business. But unlike sectors like tech and crypto, the business cycle has moved in the opposite direction for commodity traders, cushioning the blow, allowing them to post record profits even as interest rates rise.
According to consulting firm Oliver Wyman, the industry earned an estimated $115 billion in 2022, even when costs such as freight and financing are factored in, an increase of almost two-thirds from the previous year.
Interest rates are just one of the costs involved in a typical commodity transaction – even if products have to be transported from one port to another, vessels have to be chartered and travel insurance arranged. Then there is the cost of hedging derivatives to secure the price of the freight and collateral in the form of margin to enable these positions.
However, the industry is particularly vulnerable to rising interest rates as trading houses rely on bank loans for the vast amounts of money needed to purchase, transport and store large quantities of commodities.
The interest accrued quickly adds up: At current prices, for example, a typical LR1 tankerload of heating oil might cost around $46 million, and a medium-sized oil trader is likely to have several on the road at once. Retail giant Trafigura Group had credit lines totaling $73 billion at the end of last fiscal year and has a network of about 140 banks around the world.
One area where interest rates are a key factor is when traders buy and hold commodities. For example, storing metal in warehouses for a convenient time to sell has been a feature of the aluminum market since interest rates were cut to near-zero levels following the 2008 financial crisis.
As interest rates have risen, futures prices have traded at an increasing premium – or “contango” – to spot rates to reflect higher holding costs. But even the broadest contango since 2008 is only just enough to offset more expensive financing, said Duncan Hobbs, director of research at metals trader Concord Resources Ltd.
“The spread needs to move outward to compensate, and if that doesn’t happen, you can imagine some people going out of this space,” he said.
In other cases, increased financing costs for dealers are reflected in higher prices for end customers. The cost of small-volume oil contracts for Caribbean-based buyers “has risen very sharply this year,” said Michael Winstone, director of crude and heating oil at trading house Novum Energy Trading Corp.
“It depends on the exact logistics, but I think with the financing costs on top of the higher shipping costs, some of our diesel and heating oil sales contracts have gone up between $6 and $10 a barrel,” he said.
The ability to keep profits steady by raising prices and maintaining margins can sometimes be a matter of scale, and mid-sized companies are under more pressure, BCP’s Galtié said.
Still, even the biggest players have to weigh the added cost.
“Currently, liquidity is limited and capital is expensive. So if you want to operate in the market, you need higher margins to cover your operating base,” explains Christopher Bake, board member of the world’s largest independent oil trader, Vitol Group. said at a panel discussion during International Energy Week. “It’s getting harder.”
–Assisted by Jack Farchy and Mark Burton.
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