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Section B HOW TRADING WORKS

Chapter 5 Chapter 8 Sourcing : Blending commodities: working with producers transformation in form p.3 p.15 Chapter 6 Chapter 9 Transporting commodities: Delivering commodities: transformation in space meeting specifications p.5 p.23 Chapter 7 Storing commodities: transformation in time p.11 2 Section B. How Commodity Trading Works Chapter Introduction

How Commodity Trading Works INTRODUCTION

This guide sets out to present a thumbnail portrait reflected here. Deliberately and inevitably, we have of commodities trading. The aim is to inform readers focused on energy, and trading, and about the specialist nature of the and the have made only passing reference to trading services it provides, as well as to dispel some of agricultural products. the myths that have grown up around trading over We have tried as far as possible to capture factors the years. that are generic to commodity trading firms and It makes clear that this is at its core, a physical their basic functions and techniques. and logistical business, and not the dematerialised, This section explores the nuts and bolts of the speculative activity that is sometimes suggested. trading business and the links in the supply chain, The Group, one of the world’s largest from sourcing the commodities from producers, independent commodity traders, with a focus on oil transporting them by and , and storing them and products and metals and minerals, in terminals, tanks and warehouses, to blending them is at the centre of the narrative. to meet ever-varying customer specifications and The focus is designed to provide delivering them to the right places at the right time. concrete case studies and illustrations. We do not claim that this is a definitive guide to all facets of the . Other firms than Trafigura will have their own unique characteristics, which are not 3 Section B. How Commodity Trading Works Chapter 5. Sourcing commodities: working with producers

Chapter 5 SOURCING COMMODITIES: WORKING WITH PRODUCERS

Trading firms aim to maximise the differential between the price they pay for (untransformed) commodities and the they earn by selling (transformed) commodities. Minimising the overall cost of acquiring commodities is therefore a priority. They with producers to secure long-term, cost-effective supply.

Reducing overall cost Trading firms have to deliver shipments at their Despite changed dynamics, the majors* customer’s preferred location and they have to meet still control a sizeable proportion of commodity grading criteria and thresholds. If they buy from supply chains. They operate many of the largest producers in remote, inaccessible locations, transportation mines and oilfields. They have long-term costs are likely to be high. If they buy from smaller mines, with processes optimised to meet their output. They it is harder to achieve of scale. Traders often use tried-and-tested routes and invest in work with producers to optimise or scale up . specialist logistics. It all helps to minimise the total cost of delivery. Focusing on quality Most independent traders do not own their own The pace of growth in Chinese demand has forced traders sources of production. They search far and wide to to look further afield for supplies and quality has suffered. identify and acquire low-cost, marketable . The average content in ores has fallen from 2 To do that, they need boots on the percent to less than 0.6 percent over the last two decades. Trading firms need ground – people who understand the With low-quality raw materials, smelters require more to factor in shipment, local culture, who are able to adapt to concentrate to produce the same amount of copper. The processing and its priorities. concentrate may include impurities, arsenic for instance, scaling costs Independent traders can incur which need to be managed. It all adds to delivery costs. significant costs when they bring new Process quality is equally important. There are producers to market. It is not just about the headline high-quality deposits in ’s copperbelt, but trading price. Lower cost producers may be smaller operations firms need to be careful where they source these. with limited access to global markets. The trader has Some mines, especially in conflict areas, do not the task of making their products globally competitive. conform to international health and safety standards.

* majors: BHP Billiton, , Rio Tinto. Oil majors: BP, Chevron, Exxon Mobil, Shell, Total 4 Section B. How Commodity Trading Works Chapter 5. Sourcing commodities: working with producers

This matters for the trading firm. In a world that is Pre- agreements moving towards increased , suppliers that More typically the commodity trading firm makes a source from mines with poor social, environmental and pre-payment for future supply. This arrangement is production performance run a significant reputational . popular in many -rich but cash-poor developing countries that might resist outright Improving competitiveness and marketability foreign of their natural . Many trading firms develop specialist logistics to Commodity pre- are a useful substitute support multiple, smaller producers. Trafigura is for the loans that emerging economies find investing heavily in Colombian . increasingly hard to get from international . In Brazil, its -of-the-art multimodal For commodity traders making the pre-payment terminal, a joint venture with Mubadala, has direct there is a risk that the commodity to be delivered rail links to miners in the country’s quadrangle. will fall in . However, there are mechanisms to Traders can gain a sustained competitive deal with this. The producer can for instance agree advantage by developing advanced logistics in to make up any fall in with a cash countries where there are no viable alternatives. Their payment or extra supply of the commodity. logistics networks can transform and transport Offtake agreements give producers of commodities at lower cost than their competitors. demand and commodity traders security of supply. But these are long-term and they need Commodity traders are unlikely, in every case, to tie to work in with local communities. a specific volume of crude to a specific agreement Firms will also provide technical or financial to supply one particular refinery, or dedicate copper resources to help producers modernise and extend concentrate to serve a particular smelter. They production. These are often linked to long-term wouldn’t be traders if they were to forego the purchase arrangements, known as offtake opportunity of getting the best price for their offtake agreements, where the trader agrees in advance to volumes. But the existence of some steady long-term buy a minimum percentage of the mine’s output over supply coming into their commodity portfolios does several years. allow traders to sign longer-term supply agreements with refiners, smelters and processors. Securing supply There are many ways of securing supply, one of which is ownership of oil and gas fields and mines. Common WAYS COMMODITY TRADING FIRMS SECURE ownership of the and of all the means RELIABLE LOW-COST SUPPLIES to process, transport and market it can make sense. There are several examples of upstream integration. Glencore, after its merger with Xstrata, has effectively become an integrated mining 1 Upstream integration company. has upstream oil and , and Vitol owns upstream oil assets. Trafigura owns mines in Spain and Peru. However, a more usual way to secure Offtake agreements supply is through long-term offtake 2 Joint ventures and upstream agreements with producers. Sometimes integration secure such agreements follow on from a spell long-term supply of ownership by the commodity trading firm. Trafigura, for example, Pre-payment and offtake bought a Peruvian mine in 1997 and spent the 3 agreements following 16 years improving efficiency and extending its life. When it sold the mine in 2013 it signed an agreement to take 100 percent of its output. Commodity trading firms sometimes combine an initial (perhaps in the form of a 4 Technical support joint venture) with offtake agreements to get supply flowing. 5 Section B. How Commodity Trading Works Chapter 6. Transporting commodities: transformation in space

Chapter 6 TRANSPORTING COMMODITIES: TRANSFORMATION IN SPACE

Many producers are found in remote locations, often in emerging economies. Traders need to deliver commodities to centres on the other side of the world. They can increase their profitability and generate more physical opportunities by lowering transportation costs.

Developing infrastructure Commodity trading firms rely on efficient logistics transport. These may be situated inland or at to transport commodities cost-effectively. Where the coast and will usually take advantage of the existing infrastructure is sub-optimal, there are automated processes that streamline transferral. For strong commercial grounds for investing in midstream instance, small-scale miners in Brazil’s iron ore assets – road, rail or river transportation linked to quadrangle transport their cargo on trucks to a local modern ports and terminals – that increase the collection terminal at an inland railway station. The efficiency of their supply chains. product is transferred directly onto rail freight carriages. It then travels by rail to an Atlantic Multimodal logistics terminal, where it is automatically unloaded onto a Trading firms design multimodal logistics to conveyor belt. This conveys the product to a feeder optimise and reduce shipment for a bulk dry freight tanker, which is berthed costs. They select the most efficient and ready for . Multimodal logistics transportation for each stage along the networks optimise transportation and supply chain to reduce the overall cost of minimise transferral the delivered commodity. Multimodal costs at each stage terminals optimise the transfer of of the supply chain shipments between different modes of 6 Section B. How Commodity Trading Works Chapter 6. Transporting commodities: transformation in space

Inland transportation Getting product from one part of the world to another brings many different modes of transport into play. The main inland modes of transportation include:

Trafigura reinvents logistics in Colombia Following the collapse of the state-owned railway company in 1990, Colombia’s rail network disintegrated. It put immense strain on the road system as the only viable means for transporting cargo. It led to a situation where transporting freight 500km overland by road from Bogotá to the country’s main Pacific port at Buenaventura was more expensive than shipping that same load the 15,500 kilometres by sea to . Trucks Rail Barge Fixed pipeline Trafigura has invested over $1 billion to help to Delivery by Low unit cost, Like rail, this is Low unit cost, develop the country’s strategic infrastructure and road is probably large-scale a low unit cost but high reduce its reliance on an overloaded, inefficient the most shipments. Rail transportation costs. Pipelines road network. flexible also offers alternative ensure Its ambitious plan is revolutionising mechanism, but high-speed where there is a continuous Colombia’s logistics. Trafigura subsidiary Impala individual delivery and the suitable river. supply and are Terminals is coordinating an operation to shipments are ability to build This will also most suitable connect the Caribbean Sea to the country’s not easily direct rail links require for traders with hinterland by opening the 1,500-kilometre scalable. Trucks between substantial a steady flow of Magdalena River to freighty traffic. are best producer and initial With its multimodal logistics network in deployed to ports. It may investment. orders and Colombia, the trading firm can move product to manage require a high Terminals and control of and from Colombia’s interior. A giant oil terminal at complex routes initial barge fleets are substantial Barrancabermeja on the Magdalena river is and difficult investment. needed. The terminal exporting and importing crude and naphtha using terrain. ability to capacity. motorised pushers and barges. arrange direct Trafigura’s river transport system is helping river-to- Colombia to unblock the logjam that has transfers at constrained its . In return, seaports can be the company gets access to a sizeable new market. advantageous. 7 Section B. How Commodity Trading Works Chapter 6. Transporting commodities: transformation in space

S SS SS S

S

Ultra Large Crude Carrier 320,000-550,000 DWT

Very Large Crude Carrier 200,000-320,000 DWT

VeryOver Large 200,000 Bulk Carrier DWT

Suezmax 120,000-200,000 DWT

Aframax 80,000-120,000 DWT Capesize Panamax 60,000-80,000 DWT Panamax 100,000-200,000 DWT Supramax Product tanker 60,000-80,000 DWT 10,000-60,000 DWT 45,000-59,000Handysize DWT 10,000-35,000 DWT 8 Section B. How Commodity Trading Works Chapter 6. Transporting commodities: transformation in space

Overseas transportation Wet and gas freight Just as commodity trading firms need onshore In certain markets there is a need for specialist facilities to load, offload, store and blend cargoes, so carriers and here it can sometimes make sense for they need to carry their cargoes across the traders to own their own shipping. LNG, LPG, propane oceans. However, unlike terminals, commodity and butane are transported in refrigerated carriers trading firms do not need to own their own vessels. to keep the gas as a supercooled liquid. Bitumen Ships are interchangeable and port facilities are not. carriers are specially adapted to allow the cargo to They may charter wet freight tankers to transport be heated so it doesn’t solidify. Having its own fleet oil and petroleum products. Metals and minerals – of special purpose carriers helps a firm to avoid the dry freight – are transported in bulk carriers. risk of chartering vessels in a narrow, illiquid market There are two main ways of doing this: and means it is better able to keep commercially • A time charter is like renting a car: you pay for the sensitive transactions confidential. daily hire, fuel and any parking fees, while the cost of maintenance, and licensing is paid by Freight market dynamics the rental company. Freight specialists aim to minimise transportation • With a voyage charter, the charterer pays a metric costs, but factors can greatly tonne freight rate for the cargo to be carried from affect operational expenses for particular vessel point A to point B. The ship’s owner or types. With voyage charters, they need to locate a Trading firms use time charterer pays fuel and port charges. vessel with the ability to load their cargo and berth time charters and voyage charters Time chartering is extremely flexible. at the required locations at the agreed times. for overseas Time chartering a ship – for a month, a Time chartering provides more flexibility, but to transportation year or more – gives the charterer full be cost-effective, these vessels need to be fully as needed commercial control. He pays for fuel and utilised across the chartering period. Trading firms port charges. At any time during that often have freight desks that make idle time- period he can put it out for re-hire for individual chartered vessels available to third parties. Freight voyages or indeed for another time charter. The traders aim to mitigate freight risk by hedging their owner retains the technical responsibilities of future freight obligations using swaps or forward crewing, insuring and maintaining the ship. freight agreements (FFAs). Bunker fuel, another major Most trading firms supplement time charters cost of chartering, is also subject to market volatility. with voyage charters to maximise their ability to Traders use bunker derivatives to their future take advantage of short-term and fuel costs. trading opportunities. Chartering terms are set out in of Affreightment (COAs). These include Incoterms, Shipping and chartering desks which specify rights and responsibilities. They also Commodity trading firms normally operate shipping specify penalties, such as the demurrage fee payable or freight desks. to the owner if the vessel takes longer than agreed They act as providers to the company’s to load and unload. traders, getting them competitive freight rates and Newer, cleaner and more efficient vessels are hedging freight rate risk. progressively replacing older ships in the current They will often also trade a portfolio of shipping global fleet. Many regulators have reduced the services for third-party customers, booking voyage maximum permissible sulphur content in bunker fuel and time charter clients when they have unused in recent years in response to environmental concerns. capacity, and pursuing freight arbitrage opportunities In the medium term, these dynamics may to a for the company. shortfall in the supply of suitably located and equipped vessels, with a consequent increase in chartering costs. 9 Section B. How Commodity Trading Works Chapter 6. Transporting commodities: transformation in space

Liquefied (LNG) markets Commercial arrangements limited to a defined Gas, the greenest of the fossil fuels, is difficult to set of buyers (who in turn would often have transport globally and that restricts its tradability. monopolistic franchise areas). Russia, the most landlocked of major energy As more re-gasification capacity has come on- producers, delivers most of its gas by pipeline. Pipeline stream, particularly on floating barges, international gas generally goes straight from the producer to the LNG trading is opening up, taking on more of the consumer, with no real role for intermediaries. characteristics of a standard . A But pipelines are impractical where producers and small but growing of international LNG trade are separated by sea. LNG transportation is taken by trading firms selling gas from a global provides an effective solution. portfolio and benefiting from arbitrage opportunities LNG works by cooling natural gas to minus 162 between the various regional . degrees centigrade. This liquefies the gas and shrinks An estimated 20 percent of LNG volumes is now it to 1/600th of its gaseous volume. The liquid traded on the spot market (though in this long-term concentrate is transportable in purpose-built business, spot contracts can last up to four years) refrigerated tankers. through aggregators and traders. The technology was developed several decades The evolution of LNG markets demonstrates that ago and began to be used commercially in the mid- a requirement for significant investment in long-term 1960s. Liquefaction and re-gasification capacity capital projects technology is no bar to the developed rapidly until the 1980s, then stagnated development of effective traded markets. Craig until the mid-1990s, but has picked up since. Pirrong has observed that “expensive, durable is the global industry leader, but is now investments in specialised capital [projects] are being joined by new exporters, chiefly Australia but completely compatible with spot market also the US and countries in . complemented by transfer mechanisms. Early LNG contracts were long-term arrangements, In essence, liquid markets create security of supply < TRANSPORTING GAS locking producer and consumer into a virtual pipeline and security of demand3”. that did not allow any intermediary trading.

3 Fifty Years of Global LNG, Craig Pirrong, 2014

Top ten exporters of gas UK 48.35 GLOBAL LNG SHARE OF TRADED GAS (pipeline and LNG combined) in 2017 Mexico 49.45 (billion cubic metres)

Source: World Oil and Gas Review 2018, ENI 51.49

Germany 119.50

Malaysia 36.79 Netherlands 47.54 52.05 Japan 117.16

Turkmenistan 53.76

China 89.49 Turkey 54.14 Algeria 54.74 Russia 221.05 VESSEL Italy 68.05 2000 2005 2010 2011 2012 2013 2014 2015 2016 2017 Australia 69.20 US 83.89 vs Qatar 127.93 PIPELINE

Norw

Canada 84.76 a y 124.27 Top ten importers of gas ee (pipeline and LNG combined) in 2017 pee US 86.85 (billion cubic metres)

Source: World Oil and Gas Review 2018, ENI Source: World Gas and Renewables Review 2018, Vol 2, ENI 10 Section B. How Commodity Trading Works Chapter 6. Transporting commodities: transformation in space

Bitumen markets Not too long ago, the bitumen trade was regarded as a regional business. The specialised ships required to transport the product tended to be relatively small, making it difficult to achieve the economies of scale needed to make global trade worthwhile. In recent years, however, this has started to change. Bitumen shipping and trading go hand in hand, because the ship is needed to make the trade. And bitumen carriers are highly specialised, built with containers that continually heat the bitumen at 150°C so it does not solidify. Puma Energy’s bitumen carriers are some of the largest in the world. Weighing in at 30,000 tonnes each and 40 percent more fuel-efficient than their traditional counterparts, these kinds of ships are helping to globalise the market. They can transport bitumen from the US Gulf to Australia and back again without having to stop to refuel. Budgets for road construction and maintenance – which account for about 85 percent of bitumen use globally – are largely tied to spending. Public investment has been lacking since the 2008 < TRANSPORTING GAS financial crisis in the developed world, but China and countries in Africa are major growth markets.

Top ten exporters of gas UK 48.35 GLOBAL LNG SHARE OF TRADED GAS (pipeline and LNG combined) in 2017 Mexico 49.45 (billion cubic metres)

Source: World Oil and Gas Review 2018, ENI France 51.49

Germany 119.50

Malaysia 36.79 Netherlands 47.54 South Korea 52.05 Japan 117.16

Turkmenistan 53.76

China 89.49 Turkey 54.14 Algeria 54.74 Russia 221.05 VESSEL Italy 68.05 2000 2005 2010 2011 2012 2013 2014 2015 2016 2017 Australia 69.20 US 83.89 vs Qatar 127.93 PIPELINE

Norw

Canada 84.76 a y 124.27 Top ten importers of gas ee (pipeline and LNG combined) in 2017 pee US 86.85 (billion cubic metres)

Source: World Oil and Gas Review 2018, ENI Source: World Gas and Renewables Review 2018, Vol 2, ENI 11 Section B. How Commodity Trading Works Chapter 7. Storing commodities: transformation in time

Chapter 7 STORING COMMODITIES: TRANSFORMATION IN TIME

With inelastic supply and demand in commodity markets, supply and demand shocks have the potential to create volatile market conditions. Trading firms store commodities to help bridge this gap and keep markets in balance. They own and control midstream infrastructure and maintain large at strategic locations around the globe. Traders earn profits over time by reducing when there is excess demand and building up when there is excess supply.

Why trading firms invest in A strike at a mine, political unrest, unseasonal midstream infrastructure temperatures – supply and demand shocks Commodity traders consider the full control of in commodity markets can have many different midstream facilities that comes with outright causes, and they can occur at any time. What is ownership vital to their trading business. All major more, both supply and demand are price inelastic. commodity traders own midstream infrastructure, Producers cannot easily open or close mines or including loading and offloading terminals at ports, wells; for consumers, commodities are typically and storage and blending facilities, which are also seen as necessities. usually at ports. These conditions can make for highly volatile There are considerable positive synergies between markets. Commodity storage plays a vital their core trading function and ownership of this kind economic role by helping to dampen Traders want to control fixed assets of logistical infrastructure. volatility and bring markets back into to be able to move balance. Market participants can offset commodities swiftly Temporal specificity the effect of market shocks by adjusting when market The economic concept of temporal specificity helps inventory levels. When demand exceeds conditions dictate to explain why midstream infrastructure is supply they reduce storage levels. In strategically important. oversupplied markets they can bolster underlying demand by increasing inventories. 12 Section B. How Commodity Trading Works Chapter 7. Storing commodities: transformation in time

Trading firms facilitate the process. They earn Security and optionality arbitrage profits by releasing or increasing inventories Control of midstream infrastructure also gives traders while simultaneously creating offsetting positions in security of supply. This enhances their strategic futures markets. flexibility and improves their ability to deliver globally Trading firms gain a by at times that suit their customers. maintaining inventories their own facilities. Arbitrage opportunities are, by definition, transient. The cost and trading relationships of even a short delay in obtaining can be Infrastructure to make more competitive is considerable. Firms that store their commodities in welcome in many economies, especially in those that a facility they do not own or control risk not being do not have the resources or the expertise to do this able to exploit such opportunities. themselves. This kind of investment unlocks new To execute arbitrage successfully, traders need markets and opens doors to new suppliers. instant access to their assets. Knowing this, facility Trafigura subsidiary Impala Terminals’ investment, owners may try to charge premium rates by, for along with Mubadala, at Porto Sudeste in Brazil offers example instituting delivery delays and enforcing an smaller independent iron ore miners an export outlet. artificially high price for an ‘express’ service. Such It is also a platform for the company to develop new hold-ups don’t occur if the firm executing the relationships in the region. Its river infrastructure arbitrage also owns the storage facility. programme is strategically vital for Colombia. Its As markets become more transparent, arbitrage involvement is generating goodwill in the country opportunities are increasingly transient. The more and helping it forge crucial long-term partnerships acute this temporal specificity becomes the greater with private and public sector concerns. the incentive to invest in midstream infrastructure. Traders do not face the same with floating Ownership and control storage facilities. Most commodity traders own All of these factors help to explain the increased asset terminals and storage facilities, but very few have intensity of trading firms in recent years. It also raises their own bulk carriers or tanker fleets. The owners a question: if midstream infrastructure assets are so of fixed logistic assets face little . There valuable, why do commodity trading firms sometimes is little to stop them holding up delivery. However, choose to sell them? bulk ships and tankers are mobile. If a ship owner It partly comes down to culture. Trading firms tried to delay delivery the charterer would simply exist to service the need of producers and consumers take their business to a competitor. as such they buy and sell opportunistically. That extends to fixed assets, especially when there is a Adding value though logistics that outweighs the trading advantage As commodity producers have got better access to of holding onto the asset. price information and become more sophisticated It is also strategic. Unlike Glencore and Noble, the at their products, the margin on four big private commodity trading firms, Vitol, pure trading activities has declined. Trading firms , Mercuria and Trafigura, cannot raise equity increasingly need to add value by offering integrated finance on markets. They need regular capital logistical services for their customers. They are better infusions to build up their balance sheets or make equipped to do that if they invest in further infrastructure investments. Asset sales can Trading firms infrastructure. be an important cash-raising tool. benefit more from Global trading firms with substantial And it is important to remember too that control investing in throughput are best placed. Trading firms does not necessarily require ownership. A good midstream assets that control a substantial fraction of the illustration is Trafigura's construction, then partial where they have assets at a particular midstream facility sale, of an oil storage and export facility at Corpus substantial benefit from the advantages of scale. Christi, Texas (see page 54). The company sold a throughput Being able to deliver more efficiently gives majority stake to a specialist operator in 2015, but them a competitive edge in the region. before doing so it made sure it retained the rights to all future production. 13 Section B. How Commodity Trading Works Chapter 7. Storing commodities: transformation in time

Contango and backwardation A trader can buy a commodity for delivery on a date fall below the current spot price, is known as in the future in one of two ways. He could either backwardation. borrow now to buy the commodity today, The period starting in mid-2014 was one of and store it until the desired delivery date extreme volatility in crude. The oil price collapsed (at which point he repays the borrowing) or he could from over $100 per barrel in June to less than $50 buy a commodity futures . at the end of the year. And the market moved into Since these are different ways of achieving the a contango pricing structure. same objective, their relative costs are connected. Traders were incentivised to buy physical oil Prices in commodity spot and futures markets are in the spot market and increase storage levels. linked by arbitrage. When one purchase method In doing this, they were also helping to balance becomes relatively cheap, traders can arbitrage the supply and demand. price differential. They buy in the cheaper market All the leading traders sought to make the most while simultaneously selling in the more expensive of the situation by taking on additional storage market. This adjusts supply and demand, and capacity. As most of the world's available on-land therefore relative pricing, in the two markets. storage tanks filled up, some fixed long leases on But there are also times when, for technical supertankers to store surplus oil on the high for reasons, the markets can move apart. When futures periods of up to 15 months. This practice was last prices drift higher than spot prices, markets move seen when oil demand collapsed during the 2008 into contango. The opposite situation, when futures financial crisis.

Impala Terminals Global storage for oil Trafigura’s wholly owned logistics and and petroleum products infrastructure industrial investment Impala Trafigura stores petroleum products on land and in Terminals manages the group’s metals and floating storage at strategic facilities around the minerals infrastructure assets. It designs, builds, globe at third-party owned terminals, and with its owns and creates multimodal logistics chains that midstream and partner Puma Energy. link inland ports and deep sea terminals across Independent audits and regular due diligence many countries globally. ensure that all storage facilities meet international It has three main areas of operation – South best practice standards. America, Africa and the US. Puma Energy manages close to 8 million m3 of In Peru, it has expanded a warehousing and storage at modern facilities at over 49 countries blending facility at Callao, the country’s main across the Americas, Europe, Africa, the Middle East commercial port, into one of the country’s largest and Asia-Pacific. These are strategically placed at sites for copper, and lead concentrates. In global energy hubs and locations with strong Colombia, it is helping to create multimodal (barge, multimodal transport links. truck and rail) transportation across the country. Puma Energy handles many different products, The Magdalena river project, once completed, including crude, fuel oil, clean refined products, will handle 1.5m tonnes of cargo a year. In Brazil, bitumen, LPG and petrochemicals. Its high-volume Impala’s $2bn joint venture investment with bulk-building and bulk-breaking services allow Mubadala, the UAE sovereign fund, to traders to split or combine products for resale. It operate a new port facility at Porto Sudeste is also provides access to infrastructure with rail, giving smaller independent miners a cheaper and truck, pipeline and discharging services. more convenient outlet to world markets. In Africa, Impala is getting copper concentrates out of the central copper belt of the DRC and Zambia by road and rail to the key southern African ports for export. In Louisiana, US, Impala has bought and expanded the Burnside terminal. It is now the only terminal on the Mississippi big enough to load coal, bauxite and between barges and ocean-going vessels, and in the future, directly to and from rail cars. 14 Section B. How Commodity Trading Works Chapter 7. Storing commodities: transformation in time

The Brent futures curve moved from backwardation in May 2014 to contango in May 2015 to super-contango in November 2015 and back to contango in May 2016

BRENT CRUDE OIL SPOT PRICE: MAY 2014 - MARCH 2019 120

100

80

60 $/barrel

40

20

0

May-14 May-15 Nov-15 May-16 May-17 May-18 Mar-19

Source: http://www.tradingeconomics.com/commodity/brent-crude-oil

BRENT FUTURES CURVES: MAY 2014 - MAY 2016

Brent spot rate Brent $ premium/discount to $ premium/discount

a a a Months to delivery

Source: Trafigura research, 2017 15 Section B. How Commodity Trading Works Chapter 8. Blending commodities: transformation in form

Chapter 8 BLENDING COMMODITIES: TRANSFORMATION IN FORM

Since commodity producers derive their product from the ground, its quality and characteristics are variable. To be fit for purpose, physical commodities need to be matched to customer specifications.

Traders and intermediaries bridge the quality gap by techniques to reduce the levels of arsenic, blending commodities from multiple sources to make phosphorous and other unwanted materials in products that match customer requirements. They shipments in return for a higher price. In iron ore and earn profits by identifying and exploiting market coal markets, blending is primarily a mechanism for inefficiencies in the price / quality relationships enhancing profitability. between different shipments of a physical commodity. Traders need to be able to store products from Suppliers provide products that at least meet the multiple sources at a strategic location where there customer specification, but the complexity of the is the capability to blend at scale. They could in refining process is such that to do this they will theory rent such facilities from third parties, but most sometimes present an over-specified product. Traders prefer to control or own their own infrastructure. and intermediaries use blending to optimise Transaction economics and the concept of temporal shipments so they can meet customer specifications specificity shed light on the reason for this. at a competitive price. Arbitrage opportunities are fleeting. If a change in relative pricing between two grades of a commodity Strategic infrastructure creates a blending opportunity the trader must be In metals and minerals markets, traders often able to react swiftly to exploit that. If its product is combine materials from two or more mines to create held in a third-party owned facility the trader's commodities with the desired qualities synthetically. may not be prioritised. There is a risk that In concentrates markets – copper in particular but the third party may even use the situation to extract also zinc, lead and other metals – they use blending premium rates. 16 Section B. How Commodity Trading Works Chapter 8. Blending commodities: transformation in form

BLENDING PRODUCT TO CHINESE SPECIFICATION

BUY BLEND SELL COPPER CONCENTRATE AT TERMINAL TO CHINESE SMELTER FROM MINISTRO HALES

ARSENIC 7 ARSENIC CONTENT 'CLEAN' CONTENT + CONCENTRATE = 4% UNITS 0.5%

Blending in copper markets techniques such as oxidisation can reduce arsenic Chinese copper consumption has grown markedly content, these are costly and they also affect copper since 2000. In 2002, China had already overtaken levels. For instance, processing at Toromocho which the US to become the world’s largest copper reduces arsenic from 1 percent to 0.7 percent, also consumer. By 2014, it was consuming 8.7 million cuts the copper grade in the concentrate metric tonnes of refined copper products, 40 percent from 26 percent to around 22 percent. Blending of global demand. Another solution is to blend the concentrates China processes increasing amounts of its copper concentrate. Mines producing arsenic- reduces toxicity domestically; it accounts for over a third of global rich concentrate sell at a discount to smelter production. But with few exploitable trading firms, like Trafigura, which also reserves domestically, it has to source most of its have access to cleaner stocks. The traders then blend copper overseas. the material with cleaner concentrates before selling The quality of concentrate available has suffered on to smelters. with the growth in demand. As existing mines get Low-quality concentrate requires larger inventories depleted, smelters are more reliant on new, sometimes and more extensive processing. This is reflected in arsenic-rich, sites for their concentrate. The the price. The premiums payable on cleaner Toromocho mine in Peru, which came on stream in concentrates vary according to market conditions. 2014, and Codelco’s Ministro Hales project in northern Chile, which began production in 2015, are Blending coal for power plants significant new sources of copper supply. Both The rationale for blending coal is purely economic. produce concentrate with high arsenic content: Trading firms source products from multiple locations 1 percent at Toromocho and around 4 percent at and blend to meet customer specifications in the Ministro Hales. most cost-effective way possible. running These new flows of arsenic-rich copper concentrate coal-fired power plants are important customers. present fresh challenges for the industry. Concentrate Japanese and Korean plants have more exacting containing arsenic poses health and safety risks for quality requirements. They typically negotiate long- smelters and China insists on a maximum 0.5 percent term contracts, often direct with producers, to secure arsenic content for . Although processing consistent quality product. 17 Section B. How Commodity Trading Works Chapter 8. Blending commodities: transformation in form

Power plants in China, which face less exacting Market forces dictate spreads between lumps and environmental standards and stretching demand fines and for the different grades. Trading firms blend conditions, are often more flexible about the grades accordingly to maximise their margins, aiming to of coal they use. They are also active in spot markets source the most economic and supply the most and prepared to deal with multiple suppliers. Global popular grades by adjusting combinations of lumps trading firms sell direct or via intermediaries. They and fines. This is a scale business, which is most blend coal from different sources to supply the right profitable for firms with access to blending terminals quality product as cost-effectively as possible. and multiple sources of supply. Most traders have cornerstone contracts with key Iron ore and mills customers for the bulk of the ore they supply. They The steel industry is a major source of demand for build up inventories comprising different grades and coal and iron ore. Its market dynamics differ from types of ore to meet their requirements and will the business in one key respect: demand is supplement this by trading on spot markets with much more volatile. intermediaries and other steel mills. Historically, steel mills maintained large iron ore inventories, allowing them to respond rapidly to Crude oil benchmarks and characteristics shifting demand conditions. But in recent years, as In its natural, unrefined state, crude oil ranges in it has become more difficult for the steel mills to density and consistency, from a very thin, lightweight obtain , inventories have shrunk from 40 to 10 fluid to a thick, semi-solid oil. There is tremendous days. The mills increasingly rely on steel variation in colour, from golden yellow to very dark sales to generate cashflow and have black. The viscosity, toxicity and volatility (i.e. Steel mills have outsourced storage outsourced storage to trading firms. tendency to evaporate) of oils determine how they to trading firms Their lack of inventory contributes to can be used and transported. a see-sawing iron ore price. Rather than Key measurements for crude include American consuming iron ore and coal at a constant Petroleum Institute (API) gravity (inversely related rate, the mills ramp up production when pricing is to density) and sulphur content (low sulphur grades, advantageous and slow it down as steel demand falls. known as sweet, are less toxic). Trading firms maintain large stocks and supply Grades are described by location and specified in the mills according to need. They buy ore with detail. grades are used as pricing indices different purity levels from various suppliers and and for hedging. blend it according to customer demand. With over 160 tradeable crude oil products, many Iron ore can be supplied as lumps or in a fine- different refined products and numerous end-users ground powder (fines) at various grades of purity. with highly specific requirements, blending Mills pay a premium for high-quality lump ore as it opportunities abound in oil markets. can be charged directly into the blast furnace. Fines first have to be agglomerated into lumps, in a process known as sintering, to prevent it smothering the furnace. Lower grade ores must go through a series of processes before they can be used to make pig iron and ultimately steel. 18 Section B. How Commodity Trading Works Chapter 8. Blending commodities: transformation in form

THREE BENCHMARK CRUDES CRUDE OIL BENCHMARKS AND CHARACTERISTICS CHARACTERISTICS UNITS VALUES r Gravity ºAPI >31.1 = light 22.3-31.1 = medium Dubai 10-22.3 = heavy API gravity 31, <10 = extra-heavy sulphur 2% Sulphur WT % <.5% of mass = sweet >1% of mass = sour Brent West Texas Kinematic viscosity CST Varies from light-liquid to API gravity 38.06, Intermediate S content S sulphur 0.37% API gravity 39.06, at 40º C tar-like, nearly solid sulphur 0.24% Vanadium ppm Useful for classification Neutralisation Mg Measure of acidity number KOH/gr

eet Pour point ºC Temperature at which a ea it ht liquid becomes semi-solid and loses its flow Source: Industry characteristics

MAIN PETROLEUM PRODUCTS BY DISTILLATION TEMPERATURE

32.2° C - 104.4° C - 157.2° C - 232.2° C - 343.3° C - < 32.2° C 426.6°+ C 104.4° C 157.2° C 232.2° C 343.3° C 426.6° C

Liquefied Gasoline Jet Fuel Diesel fuel Heavy fuel oil Bitumen Other Petroleum Gas Regular gasoline Jet A1 Home-heating Normal (4%) Naphthas products Propane Premium gasoline fuel Low sulphur (petrochemicals) Kerosene Special gasolines Butane Unleaded content (2%) Light marine Premium Very low sulphur White spirit Diesel content (1%) Aviation gasoline Special fuel oils Coke Lubricant base stocks Paraffins - waxes Source: US Energy Information Administration and IFP 19 Section B. How Commodity Trading Works Chapter 8. Blending commodities: transformation in form

Blending oil products Refiners and optimisation There is no set mechanism for blending. Traders own Plants are constantly optimising their throughput or lease storage or pipeline capacity. They work with processes based on feedstock costs, most profitable partners, including the refiners themselves, to modify yields, operational issues and availability. In the US, the gasoline blend so that it corresponds closely to it is common for plants to blend shale oil with heavy pockets of demand. They may sell components for crude barrels. In the Far East, plants optimise their the fuel to the end-user themselves. inputs by blending fuel oils with crude when fuel oil Traders often make synthetic grades gets very cheap. Traders are continually looking to Traders blend crudes of crude by blending sourced grades. In identify in particular components at to make synthetic the Mediterranean, the segregation of specific locations so they can source and sell these grades for their Basrah crude into light and heavy blends to the refiners. customers They blend has resulted in traders blending heavy Blending is widely used to transform residual fuel Basrah with light crude oils to arrive at a residual fuel streams that come out of streams to make proxy for the Urals grade. In Louisiana, with precious refinery units into products for end-users. viable products little virgin Light Louisiana Sweet (LLS) crude Supplies coming from refineries vary in for end-users remaining, but with many local plants set up to take quality due to differences in refining unit it, traders have been blending crudes sourced configuration and feedstock choices. Fuels have to elsewhere to make cocktails for the refiners. While meet different regulatory standards depending on most blending takes place at energy hubs that enjoy the use of the product (the quality requirements for strong connectivity with energy transportation fuel used for vessels, for instance, differ from those routes – a typical hub would be near leasable tankage at power plants) and they vary across regions. and have ocean trade routes accessible – blending Blending is often the cheapest way to bridge the gap happens at every stage in the supply chain. It occurs between demand and supply. at the refiner, at terminals near the plant, at terminals near points of consumption and at various points The rise of the super refineries along the way. The rise of the super refinery is changing the dynamics Sometimes traders do the blending themselves. of international oil trading. For example, the trader may be able to buy discounted Refinery operations are increasingly consolidating barrels from a refiner who is producing too much into regional mega-hubs. The world’s twenty largest summer-grade gasoline as winter approaches. By (often newly-built) super refineries today are located adding in butane he can create a more cost-effective in Asia (nine), the US (five), the Middle East (four), fuel that meets the winter-grade specification. America (one) and Europe (one). On other occasions, knowledge of blending Super refineries benefit from economies of scale. requirements informs trading opportunities. Heavy They have the capacity to meet growing demand and extra-heavy crudes need to be blended with needs and the flexibility to handle up to 50 types of light crudes to reduce viscosity and improve crude oil. pipeline transmission. This is typically done at source Smaller refineries across the developed world by the producer. – which historically refined its crude locally – This happens in Canada and also in Colombia are closing in many countries, including in where state-run producers keen to export their Australia, Canada and the UK. Former refineries diluted crude oil (DCO). To do that it needs to obtain are being repurposed. For example, in 2015 naphtha and light crude that can serve as diluent. Puma Energy acquired a refinery in the UK, which it This is a costly and logistically complex exercise, but has converted into a terminal and storage it is willing to engage in this trading to get its supplies facility for refined products. Super refineries have to major market centres. Traders and intermediaries Modern refineries are better equipped more throughput, get to participate in the supply of the diluent. to produce a wider range of refined accept more types of feedstock and Similarly, downstream, with ethanol and products as well as meeting more make more biodiesel, two mandatory fuel mix products for US stringent environmental requirements, for diverse products gasoline and diesel products, distributors do the instance on sulphur. Local oil markets blending. Traders get to participate by selling them today need to be connected to these global super the required renewables. refineries. But with fewer refineries available they can be thousands of miles away from the ultimate market for the refined product. 20 Section B. How Commodity Trading Works Chapter 8. Blending commodities: transformation in form

Products need to be shipped reliably and safely to develop a product that meets the specification over large distances. Efficient hub-and-spoke refinery more precisely and therefore more cost-effectively. network and global operations offer great flexibility, and are highly responsive to changes in demand, Balkanisation and US gasoline markets supply shocks and other market adjustments. Most of us don’t think twice about the fuel we put Transportation and storage are increasingly into our cars, but the convenience of the local service pivotal in today’s global oil market, but blending still station and the ubiquity of this seemingly simple plays an important role. With the emergence of the product belie the complexity of the markets and super refineries, more blending opportunities have processes required to deliver it. opened up as plants gain the ability to accept a wider It is a common misconception to think of gasoline range of input. simply as an oil product derived from crude oil through the refining process. While straight-run The great gasoline giveaway gasoline, also called naphtha, is distilled directly from Refiners try to manipulate ingredients to meet crude, gasoline as a product is far more complex. market specifications, but they cannot always achieve The product specification varies according to this precisely. Depending on the ingredients available where it is consumed, by whom and for what purpose. and the processes they employ they may arrive at At the top level, refiners make at least two versions. an over- or under-specified blend. For the refiner, it Regular gasoline is blended for standard vehicles. may make economic sense to deliver an over- Premium grade gasoline is blended for high- specified blend. It could be that there is a performance vehicles with high-compression engines of raw materials or perhaps the complexity of that require high-octane fuel to operate at peak optimisation outweighs its economic benefits. efficiency. Even so, these are market inefficiencies and they In the US there is a proliferation of standards. create profitable opportunities for traders and other Several states have regional regulatory requirements. intermediaries. In oil trading parlance these sub- The Environmental Protection Agency (EPA) enforces optimal blends are known as "giveaways". By strict environmental controls. Unique fuel regulations modifying such blends with other ingredients traders have created gasoline zones across the country where are able to supply products that meet market only certain fuels can be sold. This balkanisation of specifications more precisely and more the US fuel supply has made it more Gasoline giveaways cost-effectively. expensive to produce and deliver fuel, but There are different are profitable for Giveaways erode refiner margins. it also creates trading opportunities. fuels in different US traders A 150,000 barrels-per-day refinery may Gasoline is a blend of 15 to 20 different states at different times of the year forego anything up to $30 million annually components. The aim is to produce a in giveaways on gasoline, distillate and clean-burning, energy-efficient, cost- heavy oil sales. For gasoline blending, refiners effective grade with low toxicity levels. Achieving often focus on minimising octane giveaways. the right combination is a complex Other dimensions of giveaways can be more complex process. Often, adding one ingredient strengthens to manage. one attribute at the expense of other Volatility in fuel fluctuates according to altitude desired characteristics. and ambient temperature. Far more than in, say, Butane for instance is a relatively cheap fuel with Europe, the US caters for these fluctuations by good burning . Gasoline with more butane allowing states or regions to specify particular blends is cheaper to produce and has higher octane levels, to reflect climatic differences; not only seasonal, but but butane’s high Reid vapour pressure (RVP) makes also geographic, such as between the low-lying sub- it prone to rapid evaporation. That limits the extent tropical Gulf, the high plains near the Rockies, and to which it can be incorporated into blends. California's Mediterrean-type climate. A refiner Volatility – a gasoline’s tendency to vaporise – is producing gasoline for multiple US states may have the key gasoline characteristic for good driveability. to make blends with several different volatilities and Liquids and solids don’t burn; vapours do. Gasoline change the volatility from month to month. has to vaporise before it can ignite in an engine’s Not surprisingly, given the amount of capital combustion chamber. In cold conditions, gasoline involved, optimisation is going on all the time. It is that vaporises easily helps a cold engine start quickly not always a case of the traders physically combining and warm up smoothly. Warm-weather gasoline is elements themselves but the aim is always the same: blended to vaporise less easily to prevent fuel 21 Section B. How Commodity Trading Works Chapter 8. Blending commodities: transformation in form

handling problems and control evaporative emissions Opportunity and optionality at Corpus Christi that contribute to air pollution. In 2011, Trafigura identified an opportunity at Refiners therefore produce blends with lower Corpus Christi in Texas to provide a faster, cheaper RVPs for use in warmer regions. Gasolines with higher outlet than the often congested port of Houston RVPs are more suitable for colder climates. for the output of the Eagle Ford shale formation. In The US maintains different RVP standards for seizing the opportunity, Trafigura transformed its summer and winter to reflect temperature-related role in the US energy markets from importing changes in performance. African crude to handling sizeable quantities of domestic crude and exporting naphtha and LPG. Summer-grade gasoline typically contains just Trafigura bought out Texas Dock and Rail which 2 percent butane. It costs refiners several cents more had a ready-made deep dock that could per gallon to produce than the winter-grade gasoline, accommodate big tankers as well as a tank . which may contain up to 3.5 percent butane. The latter particularly needed expanding as the As the has developed, new environmental highly variable output of Eagle Ford called for a standards have emerged. In the 1980s, scientists terminal with blending facilities. Over the next three years, Trafigura invested in a pipeline system discovered that adding certain oxygenate compounds, from Eagle Ford to Corpus Christi, and planned including methyl tertiary butyl ether (MTBE) and two ‘splitter’ mini-refineries, producing refined ethanol, made gasoline an easier-to-burn product product for export. with reduced polluting output. MTBE has since been Control of this infrastructure gives Trafigura a withdrawn, because of other polluting effects, but lot of optionality. It can choose to send crude to its ethanol is widely used. This oxygenated blend is splitters and then export the product. It can sell known as reformulated gasoline (RFG). crude into foreign markets. It can also sell it regionally to be blended with Light Louisiana Sweet. Environmental legislation in the US requires all And it can export naphtha to Asia, Latin America gasoline to be blended with ethanol or some other and Europe where this is a popular feedstock. non-fossil component before it can be sold to This optionality – beloved of commodity customers. The Environmental Protection Agency traders because it enables them to make (EPA) has set a 5.9 percent legal minimum level of opportunistic arbitrage – was preserved ethanol. Some states have imposed a 10 percent legal in 2014 when Trafigura sold 80 percent of its Corpus Christi operation to Buckeye Partners for minimum. Reformulated gasoline is now mandatory $860 million. Trafigura retained a 20 percent in many parts of the US, particularly in urban areas stake and commercial rights to 100 percent prone to smog. of the throughput. But ethanol has a problem: it attracts water. When gasoline mixed with ethanol is pushed through steel pipelines or plumbing at oil refineries they become much more prone to corrosion. For this reason, ethanol blending normally happens at or Refiners make BOBs near the point of consumption. that are ready for US refiners therefore produce a type blending of gasoline ready for blending with ethanol on delivery. CBOB (Conventional blendstock for oxygenated blending) and RBOB (reformulated blendstock) are the two base gasoline stocks. On the adjacent map, all of the colour-coded areas require different formulations based on RBOB. The white areas use CBOB as the base stock. Other BOBs include EuroBOB (refined in Europe for use on the US east coast) and CARBOB (a special RBOB formula mandated by the state of California). The complex nature of the US market creates many opportunities for gasoline traders. Operating profitably in these markets requires a multi- disciplinary approach. A successful gasoline trader is part-chemist, part-distributor, part-salesperson and part-logistics expert. 22 Section B. How Commodity Trading Works Chapter 8. Blending commodities: transformation in form

US GASOLINE REQUIREMENTS VARY BOTH REGIONALLY AND SEASONALLY

California

eate e

C

C

C

e er

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tha

tha

er

er

er p t ae

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Source: ExxonMobil, June, 2015. This map is not intended to provide legal advice or to be used as guidance for state and / or federal fuel requirements, including but not limited to oxy fuel or RFG compliance requirements. ExxonMobil makes no representations or warranties, express or otherwise, as to the accuracy or completeness of this map. 23 Section B. How Commodity Trading Works Chapter 9. Delivering commodities: meeting customer specifications

Chapter 9 DELIVERING COMMODITIES: MEETING CUSTOMER SPECIFICATIONS

As markets become more efficient, commodity trading is evolving into a low-margin service business. Increasingly, traders make their living by providing a solidly reliable logistics service between producer and consumer.

There is growing emphasis on service in the company, for instance, it needs to deliver its cargo commodity industry. With more intense competition in the right volumes, at the right quality, at the agreed and better information, markets are more transparent, time and at the agreed place. Should it fail to deliver, margins thinner and arbitrage opportunities more there is a high price for the end-user, with the risk of fleeting. The most successful trading firms are power outages and even popular unrest. focusing on producer and end-user priorities. This is a low-margin business. Trading firms In an industry governed by economies of scale typically earn 3 percent or less on a given transaction. and close trading relationships, there is space for Given the cost of transportation, insurance and the niche players that cater to specialist markets and operational risks they take on, this is by no means regions, and for larger global trading firms that excessive. The trading firms that deliver service can afford to invest in logistics and infrastructure most efficiently will gain a competitive advantage. that benefit their customers. Market conditions The trading firm’s role is far broader Trading firms rely on are much more challenging for medium-sized than that of a mere broker. It justifies its high-quality trading firms. involvement by the high level of service operations to The customers for commodity trading it provides to commodity producer and execute Key tenets for firms are often strategic organisations in consumer alike. Ensuring execution transactions successful delivery their respective economies, such as progresses smoothly and within profitably government agencies, energy-intensive budgeted parameters is therefore manufacturers and utilities. Any disruption in their critical to business profitability. supply chains can have far-reaching consequences. Like any other multinational business, commodity Reliability is fundamental. If a trading firm wants traders may be operating in places that are blighted to forge strong trading relationships, it has to be able by geopolitical division, subject to international to deliver commodities on spec and on time, every political sanctions, and prone to corruption and time. If it is supplying coal to a power generating money laundering. 24 Section B. How Commodity Trading Works Chapter 9. Delivering commodities: meeting customer specifications

While most commodity consumers are in All documentation needs to be accurate and up industrialised nations and emerging economies, to date. The firm’s department ensures mines and wells are scattered across the globe. They that the documents accompanying a letter of credit are usually located away from major urban areas, are in order. Before the ship carrying its cargo can often in developing economies. Trading firms may embark its master needs to sign a bill of lading, a need to create, supplement or enhance local standard form document that confirms the infrastructure to make transportation affordable. holder of a cargo shipment and obliges the carrier to Commodity trades span the globe. They can release it to them on arrival at the destination port. involve counterparties that may not know each other, Insurance provision needs to be in place. let alone trust each other. One way that trading firms It takes great care and skill to execute deals add value is by building up trusting relationships with precisely, managing continuing operational risks their counterparties. They set up detailed protocols while preserving corporate . for trading and delivery to minimise risk and maximise not disciplined enough to fulfil their various certainty. These need to be followed to the letter. obligations and responsibilities may find themselves Large trading firms manage significant numbers taking on large risk exposures quite unintentionally. of transactions. They must consider all aspects of As competition has intensified, They strengthen operational risk, put systems in place, take out alliances between trading firms and other supply chains by insurance and audit the delivery process. A company market participants – based on shared supporting their like Trafigura takes on more than 2,000 ship voyages interests, complementary capabilities customers a year. The sheer volume of activity makes it hard to and mutual benefit – have become monitor each and every risk on a given flow of increasingly common. business without a clear system and well-understood, For consumers, long-term arrangements increase carefully thought through procedures. certainty and reduce volatility. The trading firms gain Commodity trading firms employ a from having consistency of supply. They appoint relatively small number of people to specialists and WAYS COMMODITY TRADING FIRMS SECURE independent handle numerous high-volume, high- inspectors to value transactions. They put protocols in RELIABLE CONSUMPTION OUTLETS manage processes place to supervise and monitor processes on the ground so they can identify and pre-empt any problems or issues that may arise. Once the trader concludes the deal, 1 Downstream integration he hands the execution to an operator. The operator coordinates logistics to make sure all the right resources are in place for the right dates. That means working with the contracts department and the Joint ventures shipping department, appointing inspectors to 2 measure the quantity and quality of what’s in the tanker, appointing vessel brokers and agents, dealing with those responsible for loading and discharge, the terminal operator and, of course, maintaining 3 Financial support relations with the customer. The operator also has to keep the deals desk up to date with any information that could affect hedging strategy or the profitability of the trade. Operations teams focus in depth on cargo 4 Technical support certification. They assess whether the quantity and quality of the cargo needs to be certified by an independent inspector. This may be specified as a requirement in an accompanying letter of credit. Trading firms will normally appoint agents to act as 5 Long-term supply contracts their representatives, certify cargo and manage delivery of shipments. 25 Section B. How Commodity Trading Works Chapter 9. Delivering commodities: meeting customer specifications

In 2017, world copper smelter in 2017 as smelter production in Top ten copper smelter production reached over China expanded rapidly. Primary producers in 2017 19 million tonnes. Asia’s share smelters use mine concentrates of world copper smelter output as their main source of feed. more than doubled from Secondary copper smelters use 27 percent in 1990 to 56 percent copper scrap as their feed.

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i

i

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ie n

Source: Mackenzie 2018 26 Section B. How Commodity Trading Works Chapter 9. Delivering commodities: meeting customer specifications

Trading is a volume business. By locking in long- Puma Energy, originally a wholly owned subsidiary term trading patterns they are better able to invest of Trafigura, has acquired significant midstream and in infrastructure, improve economies of scale and downstream capacity. It owns and operates fuel gain competitive advantage. storage and marketing over 49 countries. But they cannot achieve this simply by providing Trafigura retains a substantial minority in goods at the lowest price. They have to engage the business and remains its most important fuel with customer problems and demonstrate how they supplier, as it is in turn Trafigura's largest customer add value. (see box below). As arbitrage becomes more fleeting, there are greater incentives to acquire assets and Puma Energy integrate downstream. Puma Energy is Trafigura’s industrial go-between in Developing new marketing outlets is a core part the oil sector. Founded in 1997, it has grown from of the trading firm’s . They pursue modest roots retailing petrol in into one various strategies to strengthen consistency of supply. of the largest independent global downstream They provide technical expertise and infrastructure companies, operating over 49 countries. support. For instance, where utility companies are Trafigura took majority control in 2000 and migrating from coal to cleaner fuels, trading firms made it the vehicle for acquiring fixed assets in the oil sector. In order to assist Puma Energy’s growth, work with them to adapt their facilities to new fuel Trafigura has subsequently opened up the capital to types. In LNG markets, trading firms are working outside , and in 2018 held 49.3 percent of with consumers to internationalise the gas business the company's shares. by encouraging take-up of FSRUs (floating storage Puma Energy provides logistics and services to and re-gasification units). third parties as well as Trafigura from its midstream In other cases, financial support can help forge assets, such as bulk storage depots and offshore mooring systems. closer links and open a new chapter. In 2015, Trafigura In its downstream business supplying petrol took a minority stake in Nyrstar, Europe’s largest zinc stations, mining companies, , shipping mine and smelter group, becoming the companies and so on, Trafigura is Puma Energy’s They extend supply largest of the company and preferred source of supply. chains by acquiring the majority owner of its operating It has storage facilities in the major hubs of downstream assets business. The two companies announced Singapore and Rotterdam-Antwerp. But it has that Trafigura would market its high- focused its growth in countries from where the oil majors have retreated, where markets are opening quality lead, zinc and specialty metals products to up and where oil demand remains strong. Nyrstar’s smelting business. It invests in territories where there is a logistical A notable development in energy markets in bottleneck in the market. In Namibia, for example, recent years is the integration of some large it bought up BP’s downstream business then rebuilt trading firms into downstream distribution in its outdated storage facility. In Australia, it has emerging markets. bought a large network of service stations and is building new terminals to accommodate big There is a strong economic case for the integration ships from international hub ports. of midstream and downstream functions in emerging markets. These markets are typically relatively small with underdeveloped infrastructure requiring additional investment. In many cases they were previously controlled by vertically integrated oil majors. When the majors exited these markets to focus on their upstream activities, trading firms, which can supply downstream markets in emerging economies very efficiently, were natural buyers. 27 Section B. How Commodity Trading Works Chapter 9. Delivering commodities: meeting customer specifications Executing the trade: operations in action

Structuring and maintaining an 3 efficient operating model is at the heart of profitable commodity 2 trading. The operations team of any commodity trader has an important role in helping to define and refine protocols that allow the trading firm minimise risk and reduce costs. 1

Managing efficient weather systems affect shipping tasks, supervise loading and execution 1 Loading and discharge speeds, fuel consumption and unloading of cargo, and are In commodity trading firms, Every day a vessel remains in dock trade routes. Charterers that responsible for arranging pilot the trading operation is at or at sea waiting to load or exceed the agreed rental period and tug-boat services. the hub of the company. discharge results in both must pay a demurrage fee. The It controls the commodity opportunity costs and actual costs operations team monitors 4 Appointing inspectors inventory and has overall for the trading firm. The contract demurrage risks and notifies Both the volume and the quality responsibility for managing between the charterer and the trading teams when schedules of commodity shipments can the supply chain activities shipowner specifies agreed time come under pressure. change while in transit. required to transform for loading and unloading Sometimes, this is anticipated transactions into profit for (laytime). The operations team 3 Vessel brokers and agents – with crude oil shipments for the company and value for needs to coordinate chartering Global trading firms undertake instance, there is always some its customers. From the dates, arrival and loading, and numerous high-volume, high-value residue left in the tanker. In other moment the deal is closed destination and discharge transactions involving thousands cases, the cargo may have been until ultimate delivery, the schedules to minimise lost time. of journeys each year. They liaise stored incorrectly, its chemical operations team is with brokers to charter vessels. properties may have changed, or responsible for execution of 2 Demurrage They use agents to manage there is a discrepancy in volumes the myriad processes Trading in the physical world logistics and represent their loaded and unloaded at various required to achieve this doesn’t always go according to interests while their ships are in stages. To prevent the expense and objective. plan. Ships develop faults, and port. They oversee administrative disruption of disagreements 28 Section B. How Commodity Trading Works Chapter 9. Delivering commodities: meeting customer specifications

6

5

8

4 7

between buyers, sellers and warehousing rental and chartering separate insurance programmes best strategy to recover value on logistics providers, trading firms costs as well as for the material for , liability, political distressed cargo? appoint independent inspectors to itself via suppliers and receivers. risk and trade credit general certify the quality and the Financing arrangements are put in insurance. The shipper may cover 8 Auditing quantity of cargo. place (e.g. letter of credit) and if a specific cargo with its own Most operations go to plan but applicable an operator tracks and policy. If not, the trading firm where this does not happen it is 5 for controls the pricings of cargo may take out special marine the of the operations team to physical flows and allocates them to shipments policies to cover shipment. work out who is at fault and Profit and loss (P&L) can be for invoicing purposes, while establish how best to recoup affected by many known or monitoring exposures. There 7 Troubleshooting money for the firm. With a unknown factors. Effective and will also be unknown or Most transactions work like complex supply chain, issues can vigilant contract is unpredictable factors, such as clockwork, but when things get arise during storage, blending and mandatory. The operations team force majeure by a supplier, bad more complex the operations transportation. The operations will keep the trading back weather or engine failure, which team has to negotiate the best team will reconcile volumes and up to date with the latest news may result in P&L impact. remedial action. Who is at fault if qualities at every stage in the while monitoring the life cycle a correctly loaded cargo arrives process to pinpoint discrepancies. of the trade. This includes 6 Insurance off-spec or the quantities can't be tracking payments and receipts The operations team checks that reconciled? Does the trader sue Play the video online for known costs such as port fees, insurance provides adequate the inspector, claim insurance or www.downloads. agency fees, inspection costs, coverage. Trading firms maintain accept the loss? And what is the commoditiesdemystified.info