Commodities

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.

For ancient warriors, it was nobler to die in battle than to escape and slowly bleed your life away. There might be a lesson there for the Asian commodities trader Noble Group: Having survived the fiercest moments of the commodities crash, it should hope the wounds it's sustained aren't mortal.

Commodities traders can still make plenty of money in a low-price environment. As with any middleman, it's not the cost that matters, but what they get for moving products from buyer to seller. Yet greater price volatility, new regulations, and a shift in the way traders get financing mean that Noble, and its competitors from Vitol to Glencore, still have a rocky road ahead.

``The markets are difficult," Chief Executive Officer Yusuf Alireza told Bloomberg TV's Haslinda Amin in an interview Thursday. ``To sit here with confidence and say the worst is behind us is just not realistic.” While the costs of the group’s revolving-credit facility had gone up, its weighted average cost of debt would remain about the same, he said.

That may sound unlikely, given credit markets' more pessimistic views of commodities, but it actually makes sense. Noble has been reducing its holdings in physical assets such as mines and grain-handling facilities to focus on the more resilient trading business, and as a result it's been able to reduce its share of expensive long-term borrowings.

Short-Term Minded
Noble has been reducing the maturity of its borrowings as it focuses more on trading
Source: Bloomberg data

Bloomberg's estimate for Noble's weighted average cost of capital -- which includes equity as well as debt finance -- hit a record low of 3.2 percent in the September quarter, from 6.4 percent a year earlier and a peak of 23 percent in March 2010.

The company can afford to do more. Traditionally, commodity trading houses could be set up with little more than a contacts book and a telephone, because almost all their borrowings were secured against physical cargoes of oil, metal and grains. Debt that's secured with collateral ought to be significantly cheaper than the unsecured variety. 

During the heyday of the commodities supercycle, that model started to wane. Lenders' enthusiasm for the booming sector pushed the spread on secured over unsecured debt so low that many traders felt it was barely enough to cover the extra paperwork. Have a look at the way the yields on two of the more-liquid bonds that Noble and Glencore issued around 2009-2010 squeezed to almost nothing, before spiking when credit markets changed their minds in 2015:

Loss of Compression
Yields on commodity traders' debt drifted downward for four years before spiking during 2015
Source: Bloomberg data
Note: Bloomberg data shows one anomalous yield figure for the Glencore bonds in November 2012. The data shows a yield of 2.361% on Nov. 16, 316.788% on Nov. 19, and 2.329% on Nov. 20. The Nov. 19 figure has been omitted to improve clarity.

Alireza plans to move Noble's balance sheet from a setup where 90 percent to 95 percent of its borrowings were unsecured, to one where the proportion is down to about 65 percent to 75 percent, he told Amin. It still needs to go further: The likes of Trafigura and Mercuria have only about 20 percent of their debt unsecured, Alireza said. That's a safer position for a commodity trader to be in, given today's bearish markets.

Rising commodity-price swings are also taking a toll.

The 30-day volatility of the Bloomberg Commodities Index, which is derived from futures prices, breached 21.5 percent a couple of times last year, the highest since August 2012, and shows little sign of abating with a current reading of 17 percent.

Random Call
Commodity futures volatility has been testing 2012 highs, increasing the odds that traders get margin calls
Source: Bloomberg

That volatility is forcing traders to hold more cash for margin requirements. If a trader buys oil at a fixed price and plans to guarantee a profit three months later with a futures position, it may have to deposit money with its broker when the price of the futures contract moves. Ultimately, when the company delivers the oil and unwinds the contract, it shouldn't have any losses. In the meantime, however, its cash is sitting in a broker account instead of being reinvested in new inventories and contracts. 

Noble ended 2015 with almost $2 billion in cash and equivalents, more than double the $904 million it had the year before. The balance with futures brokers was up 43.4 percent at $783.2 million, with $397 million of the total tied up and unavailable for operations.

Too Much of a Good Thing
Noble ended 2015 with the highest amount of cash on its balance sheet and in broker accounts
Source: Company filings

One more blow is coming from pending financial regulations.

Europe's new Markets in Financial Instruments Directive will further limit the amount of derivatives commodity traders can hold before they're considered investment firms and forced to comply with similar capital and liquidity requirements to those imposed on banks.  ``Traders may soon find it harder to hedge risk" under the rules, Bloomberg Intelligence pointed out on Wednesday.

The rules won't take effect until January 2018, but some countries are expected to start implementing them much sooner. While Noble is not based in Europe, it may find it hard to skirt the regulations, given how much commodities trade passes through the continent.

While commodity prices have rebounded so far this year, none of these factors is going away quickly. No wonder Alireza is doing all he can to reduce his funding costs.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
David Fickling in Sydney at dfickling@bloomberg.net
Christopher Langner in Singapore at clangner@bloomberg.net

To contact the editor responsible for this story:
Paul Sillitoe at psillitoe@bloomberg.net