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One topic I’ve taught about in my commodity buying and selling courses for over a decade is asset possession by commodity buying and selling companies. As my white paper for Trafigura reveals, there may be appreciable variety amongst commodity merchants’ asset possession. Some are “asset heavy” whereas others are “asset mild.”
Traditionally, the massive oil merchants – Vitol, Trafigura, Gunvor, Mercuria – have been within the asset-light class. (Glencore (OTCPK:GLCNF, OTCPK:GLNCY) transitioned to an asset-heavy mining entity with a supersized buying and selling arm earlier than the white paper was printed–extra on that beneath). Just lately, nevertheless, they’ve gone on one thing of an asset acquisition binge, shopping for refineries particularly, as this latest Bloomberg piece describes. Which raises the query: why?
The usual marketing consultant story is that belongings have optionality. This can be a superficial and incomplete reply. First, the truth that an asset has optionality says nothing about who’s finest positioned to personal the asset and train the choices. Within the case of a refinery, is it higher for an built-in oil firm to personal it? An unbiased refiner? A commodity dealer? Any of those can train the choices. Which will get probably the most choice worth?
Second, it’s usually doable to amass the fitting to train optionality through contract quite than possession. A ship (tanker or bulk provider) is the most effective instance of this. Ships have in depth optionality when it comes to route, timing, and generally cargo. Time chartering a ship provides the charterer the power to inform it the place to go when and carrying what: possession isn’t essential to train these choices. Off-take agreements from a mine or properly additionally confer rights to train choices (e.g., whom to promote the output to) with out requiring the acquisition of the mine or properly.
Transactions value economics is one analytical software to use to those points. That’s what I used to investigate contracting and possession patterns within the ocean delivery trade oh-so-many years in the past. The Trafigura white paper applies this to commodity dealer possession usually.
With respect to commodity merchants as optimum house owners of belongings with optionality, I’ve been taking part in round with a proper mannequin, the instinct for which is pretty simple. Bodily commodity merchants function in bilateral markets quite than centralized ones. Costs and values are usually not clear. Merchants are primarily worth entrepreneurs who seek for and uncover low cost provides and excessive worth patrons. Their intimate market data of worthwhile commerce alternatives might enable them to train actual choices, like the actual choices inherent in a refinery (particularly relating to selection of crude enter and the product slate), extra effectively than somebody with poorer data.
However that also doesn’t totally reply the possession query. The dealer may acquire the optionality by means of a tolling settlement, for instance. (These are usually not unknown within the oil enterprise. I recall that when JPMorgan was within the commodities enterprise, it had tolling agreements with refiners).
Additional, why is it extra environment friendly for a dealer to purchase the refiner, quite than the refiner to purchase or construct buying and selling experience? BP (BP) and Shell (SHEL) particularly are famend for his or her buying and selling experience, and even a laggard – Exxon (XOM) – has moved into buying and selling.
Since that is additionally a comparatively new growth, one should additionally ask “why now?” (And to its credit score, the Bloomberg article does simply that). Has merchants’ comparative data benefit elevated lately? That’s a tough proposition to check, however I’m skeptical.
As Bloomberg factors out, this shopping for spree comes within the wake of growth years in commodity buying and selling, and the massive merchants are awash in money. (Because the billions in bonus funds to merchants reveals). That is probably the proximate explanation for the acquisitions.
What this says in regards to the effectivity/optimality of the acquisitions is unclear. I can inform two tales with reverse conclusions.
The primary story is that this can be a basic free money move drawback. Firms with money burning a gap of their pockets are susceptible to blowing it on unprofitable investments, together with acquisitions. This was a driver behind the leveraged buyout growth within the 80s: leveraging up provides money to stockholders and precommits the corporate to make use of money flows to service debt quite than fritter it away in dangerous investments. Within the oil trade, this was T. Boone Pickens’ sport. (Tutorial analysis has proven that within the 80s, E&P corporations’ properly drilling was a unfavorable NPV exercise).
If that is the driving force behind commodity dealer refinery acquisitions, it will suggest that these purchases are inefficient. (I notice that some earlier dealer ventures into refining, like Gunvor’s, turned out badly).
The opposite story is that dealer agency possession buildings, adopted for worth maximizing causes, constrained their potential to spend money on bodily belongings like refineries. The key unbiased oil merchants are non-public companies. One of many downsides of personal possession is {that a} non-public agency can not faucet public fairness markets to fund acquisition of sturdy belongings. Relatedly, it could constrain the power to safe long-term debt to finance long-term belongings. As a consequence, long-term belongings (like refineries) should be funded with retained earnings. On this case, even when merchants can train actual choices extra effectively than an oil main or unbiased refiner, the upper capital prices inherent of their possession buildings make it uneconomical for them to amass refineries.
Arguably, the principle motive for Glencore’s transition to a publicly traded agency was that its resolution to go asset-heavy into mining was incompatible with non-public possession. It wanted to depend on the capital markets to fund this new technique.
In opposition to this value of personal possession (restricted diversification is one other) is the profit: a greater alignment of the pursuits of managers and house owners as a result of the managers are the house owners and the house owners are the managers. One motive this construction has clearly had survival worth in commodity buying and selling is that most of the different dangers – particularly commodity worth dangers – may be transferred through derivatives markets quite than the fairness markets.
The money move gusher of the previous couple of years loosens the constraint imposed by possession construction. Thus, on this story, merchants can have their cake and eat it too. They will stay non-public, and reap the advantages of higher incentives, however can spend money on fastened belongings that had been beforehand unaffordable. On this story, the constructive money move and stability sheet shock enhances effectivity quite than reduces it (as within the free money move story).
Which story is right? I’ve no sturdy opinion, however I’ll say that the governance advantages of personal possession do mitigate the free money move drawback. So I suppose I might lean in the direction of “environment friendly.”
One should additionally acknowledge that it takes two to tango. These transactions have a vendor too, in fact. Which means that “why are merchants shopping for?” will not be the one query: “why are oil corporations promoting?” can be essential.
A couple of decade in the past, merchants acquired downstream advertising and marketing operations, particularly in creating markets like Africa, from oil corporations. In that case, the event of liquid markets for refined merchandise decreased the transactions value advantages of possession by the oil corporations: the event of those markets mitigated the bilateral monopoly issues that occurred in comparatively small downstream markets served by native refineries. That decreased the advantages of possession for the oil corporations, creating beneficial properties from commerce by promoting to the merchants.
Maybe one thing comparable is happening at present in refining, particularly for comparatively “easy” (“non-complex“) refineries in Europe and Asia. When I’ve an opportunity, I’ll look into the complexity index for the refineries the merchants have acquired. With the entry of considerable high-complexity refinery capability within the Center East and elsewhere, I might not be shocked if a significant driver behind these transactions is that refiners need to shed their much less advanced operations as a result of they’ve a comparative benefit in working larger, costlier, and extra advanced refineries.
Which, sarcastically, have extra optionality: complexity interprets instantly into optionality.
In sum, the dealer refinery acquisition boomlet is an fascinating growth. It raises intriguing financial questions that I’ve simply sketched out right here. Might be fascinating fodder for an aspiring researcher – like my Université de Genève college students (trace trace, nudge nudge).
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Editor’s Observe: The abstract bullets for this text had been chosen by Looking for Alpha editors.
