Without price transparency in physical commodities markets with clear and accessible reference commodities prices, physical commodities traders are in a powerful position to profit as they have a virtual information monopoly.
Commodities Trading Companies such as Vitol, Trafigura, Glencore, Gunvor, Louis Dreyfus among others trade physical commodities taking advantage of this price opacity, investing in the physical and human capital necessary to transform commodities while simultaneously hedging their physical trades through financial (paper) trading on exchanges thus taking positions in the futures markets and the physical markets. Commodity trading firms do not tend to speculate on the outright direction of commodity prices, but instead aim to profit on the differential between the untransformed and transformed commodity specializing in (1) the production and analysis of information, buyers and sellers active in the market, supply and demand patterns, price structures (over space, time, and form), transformation technologies, and (2) the utilization of this information to optimize transformations in terms of space, time and form. Commodities trading firms attempt to identify the most valuable of these transformations, undertake the transactions necessary to make these transformations and engage in the physical and operational actions necessary to carry them out.
On top of physical trading, Commodity Trading Companies possess prop paper-trading desks. Using market intelligence coming from physical trading desks and ‘classic’ paper trading skills, these companies make profits on swaps, options and futures. They also use these paper trading books to hedge their physical exposure, which subsequently reduce their risk.These companies develop their own strategies and models - quantitative, computer-algorithm-driven or macro-driven similar to the models used in banks or hedge funds for derivatives pricing and market forecasting. They invest in physical commodities fundamental research to get an edge over their competitors and figure out where the market is going. They have on-site associates at origin and destination (offices in exporting and importing countries) to get a flavor of the local market as well as strong middle and back office for physical trading operations. They are highly skilled at managing their risks and know how to create sustainable and win-win relationships with potential buyers and sellers. Due to rising competition and change in business trends, these companies do invest at the source in mines, Exploration and Production (oil), and also transportation infrastructure such as ports. Vitol/Trafigura physically send ships to collect the cargo from the sellers, the miners and the refineries. Some like Glencore own mines (after buying Xstrata). Glencore is now a mining and trading company besides being a Commodities Trading Company. Trafigura is trading with no mining operations. It buys ore, concentrates or even refined outputs, ships them to the buyers. Trafigura model helps even for smaller operations.
Hedge funds on the other hand rarely trade physical form of commodities or take delivery concentrating only on financial or paper trading. Macro-focused hedge funds seek a hedge against an economic slowdown priced in by the market. Unlike many of their equity fund peers, commodities macro managers of the likes of George Soros and Louis Baconare are not dependent on rising markets for their gains. Rather, they look for volatility in commodities markets through 'Asset backed Trading' - a style of commodity trading which is used to seek and exploit market volatility in order to optimise the operational assets, inventory and future produce owned by trading entities. This is their core activity. However more sophisticated funds would also get into taking proprietary positions, market making and offer structured products to their clients. Hedge funds and Investment banks are beginning to exit the financial trading of commodities making daily price swings far greater than in previous years.
Financial trading is becoming an ever more important part of
Commodities producers such as International Oil Majors Shell, BP, Total driven by fears that global oil demand could drop in the next few years as climate change concerns reshape society’s—and investors’—attitudes toward fossil fuel producers. The immense scale of the commodities producers' trading units gives them outsize clout. They have massive trading floors that mirror those of Wall Street’s biggest banks. Being a commodities producer gives an inherently bigger advantage with more reliable market information in trading strategy than commodities traders suchas Vitol/Trafigura. This is also the reason why in recent years, Vitol has started looking for refining and storage assets worldwide to control a bigger chunk of the supply chain. BP controls exploration and production as well, so BP obviously has advantage over oil traders who are unable to control costs associated with these projects and an oil company like BP will make more money when the production cost remains stable while prices rise. The problem for a crude oil trader like Vitol is to anticipate the price rise and buy oil from producers at sufficiently lower price to make a profit. Sometimes, the trading strategy for Vitol is so complex that the wafer thin margins made through a trade are actually made through minimizing on transportation costs of the oil instead of the oil price itself. On one occasion in 2016, for example, Shell bought roughly 70% of the cargoes of North Sea crude available for a particular month, triggering wild price gyrations while squeezing out commodities traders who privately complained to Shell. Commodities producers are also moving into the space formerly occupied by the commodities desks of Investment Banks. Shell, for example, in 2016 became the first nonbank to help the Mexican government hedge its exposure to the price of oil. BP's customers now include banks, hedge funds and private equity firms. Exxon is also hiring experienced oil traders to start making bets with the company’s money.
