When I read through technical reports and hit the concentrate and marketing section, I’ll often see the name Glencore pop-up. The producer has generally signed a 5-year offtake agreement with Glencore with terms that are not disclosed. This company, Glencore, had always been a bit of an enigma for me. What is it? Is it a miner? A trader? A refiner? How does it make money? Why is it so prevalent within the industry?
The company’s business activities sprawl across: marketing of metals, energy, and products, and the production, refinement, processing, storage, of these products. Glencore also distributes physical commodities from third parties. The original IPO prospectus highlighted the benefits of the commodity marketing business, namely its lack of correlation with the broader market. It was this lack of correlation which was supposed to make “Glencore’s earnings less volatile than those of pure producers of metals”. Unfortunately, this thesis hasn’t really played out too well…
This result is pretty surprising. Glencore literally does everything along the value chain. How could they not be making money. Maybe they’ve just lost less money than everyone else in the commodity space.
The IPO prospectus drops this gem:
“Glencore has been consistently profitable since the management buyout in 1994 and has a track record of growth across industry cycles. Since 2001, Glencore has achieved an average annual return on equity of 38 per cent.”
It’s amazing that, despite this boast, Glencore hasn’t achieved an ROE greater than 15.6% since its IPO.
Glencore separates its business structure into marketing and industrial activities amongst the various commodity business units (below). Within each commodity unit, Glencore often owns high quality, long-lived mines (Prodeco, Katanga).
The company was originally founded by Marc Rich in 1974. This is the same Marc Rich who is credited with starting the spot oil market and was also a fugitive at large for more than a decade, only to be pardoned by Bill Clinton during the president’s last day in office. The company transferred hands from Rich to other management in 1993 and went public in 2011.
Between 1974 and 1993, Glencore transitioned from being a pure marketer of commodities to a more active role in commodity production with the purchase of smelters and stakes in mines. The ownership of mines and smelters is an interesting strategic decision. I can only assume that having a fixed supply of concentrates would allow you to enter into long-term supply contracts with guarantees provided by Glencore. No doubt, this would come with some sort of premium. This would’ve been one of the “vertically integrated” arbitrage opportunities that an individual miner would not be able to realize.
How does Glencore Make Money Through Marketing?
- Glencore sources commodities from third-party suppliers or owned mines
- Glencore provides value added services such as freight, insurance, financing, and storage
- Glencore’s arbitrage strategies can be grouped into four buckets:
- Geographic: Glencore can maximize selling prices by shipping a commodity to another jurisdiction. I’m not sure how this would work with spot markets everywhere and “paper” arbitrage. I imagine the geographic arbitrage opportunities have fallen over time. There’s probably some opportunity is smaller markets where you could literally sell something in Ghana at a higher price than in Brazil.
- Product Related: Product related arbitrage seems much more applicable in today’s environment. Let’s assume the arsenic penalties increase rapidly above a certain point. You could purchase a high arsenic concentrate (just above penalty element thresholds), blend it down, and capture the profit margin.
- Time-Related: If you have an upward sloping futures curve (contango) you could purchase the product, pay for storage, and sell forward for a profit.
- Event-Driven: Less related to true arbitrage, event driven marketing activities focus on unique, and often local supply shortages caused by weather, or other factors.
- Glencore enters into the following types of contractual arrangements:
- Purchase/off-take agreements: These agreements result in Glencore becoming the legal owner of the commodity and taking full risk in the event that the company is unable to sell the product. Often Glencore will forward sell the commodity in order to manage price risk.
Some Background on Offtake Agreements:
Mines generally sell their products under three scenarios:
- Long-term offtake agreements (2-20 years);
- Short-term contracts; and
- Single cargo spot contracts