We all thought the events of 2008/9 and the global financial crisis were bad for commodity financing, and some us well remember how the sector took a real tumble back in 1998, but none of this really prepared us for 2020. With the ravages of the Covid-19 pandemic and certain parts of the commodity sector experiencing exceptional and damaging circumstances, 2020 can safely be termed an annus horribilis for many. It is no wonder that in the TXF Commodity Report 2020 we described the year as “uncertain, unprecedented and unbelievable”.

However, the resilience of the commodity finance sector has proved itself time and time again over the years – all the way through the supply chain from production, supply/logistics, financing to end user and consumption. If 2020 had just been about dealing with the Covid pandemic, then there would certainly have been plenty of disruption, but the industry would have coped, albeit with some fallout in certain aspects particularly crude oil. What the sector wasn’t prepared for was the hit it was to take with the drastic fall of the market price of crude oil and the combination of the unprecedented collapse of several prominent commodity traders. 

Crude oil prices rock the market

Back in March and April the impact of Covid-19 and less demand for crude oil for transport combined with massive oversupply in the market created a perfect storm for the collapse of the price of crude oil.

Global oil consumption is normally around 100 million b/d, but with the impact of Covid-19 consumption is estimated to have dropped by at least a third. Oil supply did not match this. Looking at the chronology of events, within the OPEC+ group led by Saudi and Russia, in early March Saudi asked Russia to cut back on production. When Russia refused a major row broke out with each actually further upping production – Russia with an extra 2.6m b/d, and Saudi more than that. At that time Russia was producing 11.3m b/d and Saudi 12.3m b/d. The market was further swamped. Storage facilities filled up, and most of the world’s tankers became full too. Oil prices fell to an 18-year low – with Brent at $22/b. And in other parts of the market WTI futures went negative, presenting losses for many producers but opportunities for others. 

But it wasn’t until 9 April that OPEC+ announced that it was going to potentially cut oil production by 10m b/d. Venezuela, Iran and Libya were exempt from these cuts, and special arrangements were made with Mexico. At the time there were reports that some US senators were working on plans to remove US troops and hardware from Saudi soil if there weren’t oil production cuts from Saudi. 

That announcement was followed up by G20 discussions where the US, Canada, Norway and others also agreed to make cuts. The G20 also discussed measure to buy up crude to fill emergency stockpiles as well as cuts in new supplies. And the US administration said that it would look to store an additional several hundred million barrels of crude as part of a ‘national security interest’ programme. 

As may be expected, US President Trump likes to take a lot of the credit here, and at the time he tweeted: “I think I got them to cut 10m b/d, maybe even 15m b/d. Could be even 20m b/d.” Despite initial rallies, all this did not stop oil plummeting further. Much of the action taken was too little too late. The real damage had already been done by the Saudi-Russia oil price war, and by other producers not acting quickly enough to cut production because of Covid-19. The oil production cuts came into force on 1 May, and only then did they partially stabilise the crude oil price. By then severe damage had already been done to the US shale oil market with a number of players having been forced into liquidation. And African oil producing economies also took massive revenue hits.

Oil storage always plays a key part in such situations, and many of those with storage bought oil cheaply with a view to sell at a later date when they could make a decent profit. In April it was reported that Glencore had hired the world’s largest tanker to store crude. Overall, it was estimated in mid-April that here was around a total of 250m barrels of crude oil and oil products being stored in non-traditional storage – tankers at sea. Vitol and Trafigura (see below) are other traders that heavily used tankers for storage. In early April even Trump stated: “There’s oil all over the oceans right now. That’s where they are storing oil; we have never seen anything like that. Every ship is now loaded to the gills!” 

Of course many big commodity trading companies made a killing. Savvy traders bought crude cheaply, put it in storage, while simultaneously selling in the forward market, in effect locking in the price difference between the different dates. Providing the contango is wide enough to cover the cost of storage, finance and insurance, the transaction is profitable. Tanker owners and commodity trading companies were seriously the big winners in this part of the game. 

Elsewhere, Goldman Sachs commodities trading unit is reported to have generated more than $1 billion in revenues through May as its traders' bets on the oil price crash paid off. Some say that this latest crisis has also created big opportunities for investors to buy stakes in big European oil firms.

Currently crude oil stands at around $52 per barrel and some analysts predict the commodity will finish 2021 around $65 per barrel. 

Trafigura has best results ever

In a year when many businesses floundered, Trafigura showed how it is changing successfully to meet market challenges and structuring its divisions accordingly. Trafigura is a global trading house which had a sterling year financially in 2020 and profited immensely from working the oil and metals markets very successfully. 

The group reported its best financial performance ever when it announced its 2020 annual report in early December. The group recorded total revenues of $147 billion, compared to $171.5 billion in FY2019. But profits were up considerably, with net profit standing at $1.6 billion, up from $0.9 billion in FY2019. EBITDA reached $6.0 billion, up from $2.1 billion in FY2019

Commenting on the results, Trafigura’s executive chairman and CEO, Jeremy Weir, stated: “Amidst unprecedented market conditions, Trafigura’s expertise in physical commodity trading, risk management and logistics was called upon to an exceptional degree.”

He added: “For the Trafigura group, this was a year that proved and improved the strength of our business. We emerge from it with a stronger balance sheet, an improving asset portfolio and an enhanced and increasingly diversified trading platform that we believe is well placed to adapt to and to assist the accelerated global transition to a lower-carbon world. These are all reasons to be excited about the prospects for the Trafigura Group, not merely to prosper from renewed growth in the global economy following the travails of 2020, but also to play a key role in building a better future.”

All of Trafigura’s committed unsecured syndicated lines were refinanced at similar levels. The successful bond issue in September 2020 showed that Trafigura continues to benefit from a ‘flight to quality’ in commodity finance in the face of difficulties encountered by some smaller players during the year. Trafigura also continued to diversify sources of funding – for example arranging a ‘low-carbon aluminium’ financing facility - up to $500 million - at preferential rates. 

Commenting on the annual results, Jean-Francois Lambert, founder of Lambert Commodities says: “Trafigura opened the profit announcement season with a superb result for 2020. Thanks to their FY end a quarter earlier than their competitors, we have yet further evidence that the combination of high volatility and favourable forward curves during the year are magic ingredients for trading houses. 

2020 will not be a year to remember for many, but for commodity trading houses in oil and metals, it could well be a record year. We should now wait for a few months to see if Trafigura’s competitors were able to similarly take advantage of the market dynamics.” 

Trafigura’s balance sheet shows that the contango play on crude oil (and also copper) played a major role in the profit generation this year. Inventories jumped from $13.4 billion to $20.2 billion, much beyond the $6 billion of stocks in transit required for regular trading activities (the shipping division is being commended for having found the many floating storage solutions required to hoist these huge quantities of crude). 

It is also worth noting that the ratio of contribution to revenues for metal and oil & products narrowed to 43%/57%. That shows that the metal division now forms a crucial part of Trafigura’s business mix. Then again, that was expected after the Nyrstar restructuring.” 

Lambert concludes: “So overall extremely good results for Trafigura. Fossil fuels will remain a major tool for Trafigura for many years and we will witness with great interest how long it takes for the newly created power and renewables division to become a significant income earner. As to the metal division, they are already focused on the transition with cobalt, nickel, and copper trades.” 

Singaporean trading company collapses send banks reeling

Trafigura’s successes were the exception, however. The global commodity financing sector knew it was in trouble with some of the local Singaporean headquartered trading companies long before the real disruptions of the Covid pandemic kicked-in. The scandal revolving around Singaporean-based energy trader Agritrade International dominated much of the regional commodity trader discussions in the early part of this year. 

Another Singaporean trader, Hontop Energy - which is part of Chinese conglomerate Wanda Group, also ran into financial difficulties early this year when banks including DBS and Macquarie started to demand repayment of loans. Hontop filed for debt restructuring with the Singaporean High Court in March with outstanding debts totalling $469 million. In September though it was reported that Wanda Group was close to settling Hontop’s debts with two of its major lenders - DBS Bank and Societe Generale (SG). Hontop is understood to have debts with five other major banks including CIMB Bank and Natixis.

In April, and then in May, the scale of the trader troubles in Singapore was taken to an even more intense level with two other local energy traders - Hin Leong Trading and ZenRock Commodities Trading respectively – both in financial trouble, with numerous court filings from creditors and some banks looking at hefty potential losses. These cases put the spotlight firmly on the city state and questionable commodity financing activities by certain traders.

When the Brent crude oil price sank below $30/b in late March it helped expose Hin Leong’s already overextended credit lines used to cover the company’s losses. The trader defaulted on some payments, which is when the real scrutiny into its transactions began. Those subsequent investigations (see below) revealed a catalogue of alleged fraudulent activity. This and other similar cases with local traders has kept international and local law firms busy all year.

As one analyst stated at the time: “The impact of the Covid-19 outbreak combined with the collapse of the oil price has largely led to the exposure of questionable practices in the Singaporean oil trading sector, and this will have massive consequences particularly for the banks and the smaller traders going forward.” 

Hin Leong and the company’s shipping affiliate Ocean Tankers both filed for court protection from creditors in mid-April. Much has been written this year about Hin Leong in particular, and in various court filings it is claimed that the company sold large volumes of refined products it had used as collateral to secure loans from its banks. Several major commodity banks filed claims against the trader with Singapore’s Accounting and Corporate Regulatory Authority. Charges relate to alleged irregularities and discrepancies covering bills of lading, warehouse receipts, and cargoes and receivables financed by banks. 

Hin Leong then was understood to owe somewhere in the region of $3.5 billion+ to more than 20 Singaporean and international banks as well as other trading companies. Major banks understood to be creditors include ABN Amro, CIMB Group, Credit Agricole, DBS Group, HSBC, ING, Oversea-Chinese Banking Corp, Natixis, Rabobank, SG, Standard Chartered and UniCredit, to name a few. 

In late July following a two-month investigation by court-appointed independent administrators it was revealed that convoluted accounting allowed Hin Leong to overstate its assets for years. The investigators found that Hin Leong's true assets amounted to just $257 million of the $3.5 billion it had in liabilities at that time, mostly to loans from banks. Shockingly, it was also revealed that Hin Leong secretly sold some of the millions of barrels of refined products that it had pledged as collateral to secure various loans from banks. This resulted in a significant shortfall between the inventories pledged to its lenders and what the company actually held, potentially leading to big losses for the banks.

In May the Singaporean market was further rocked when oil trading company ZenRock Commodities Trading filed an application for ‘moratorium relief’, a form of bankruptcy protection, with local authorities. The company was understood to have debts of over $600 million with banks – including HSBC, Natixis, ING Bank, Credit Agricole and Bank of China + others. 

The spectacular crash of these local traders is massively damaging for Singaporean trading in general, and the reputation of the city-state as a trading and finance hub in Asia. It also raised many questions relating to regulatory control of trading companies in Singapore. Although these local trading companies are far different to the big international commodity traders that run and control the bulk of global commodities, these trading irregularities, frauds and alleged frauds are still a major reputational concern for the whole trading sector. 

But it wasn’t all happening in Singapore, in April, Phoenix Commodities, a trader of largely agricultural products with offices in Dubai and Singapore, entered into liquidation after amassing more than $400 million in potential trading losses. Phoenix, which had generated revenues of $3 billion in 2019, blamed the liabilities on currency volatility caused by the onset of the coronavirus, affecting financial derivatives linked to the US dollar and other currencies. Prior to the appointment of liquidators, the group had available banking facilities of approximately $1.6 billion with a range of commercial banks and non-banks, including: Standard Chartered, BNP Paribas, HSBC, First Abu Dhabi Bank, FBN Holdings and Chenavari Capital Solutions.

Banking fallout

Over recent years, excess banking liquidity and increased competition in the Singaporean market has led to more finance being offered to smaller traders and to looser financing structures in general. The fraud and alleged fraud, together with these trader collapses has had severe implications for many banks having to cope not only with substantial losses but also damage to reputation. The biggest casualty to the sector has been the announcement of the withdrawal from the commodity sector by ABN Amro. As a major international commodity bank the absence of ABN will be a massive loss to the market overall. 

The events in Singapore also contributed to SG announcing the closure of its commodity unit in Singapore. SG is understood to have been owed $240 million by Hin Leong alone. BNP Paribas also said it was scaling down its commodity activities out of Paris and closing its commodity office in Geneva. Other traditional commodity banks are also known to have been reviewing their activities in the commodity sector.

So it can be no surprise that the banks remaining in the game can expect to be particularly risk averse with smaller or localised traders. Going forward risk management divisions will be working overtime to scrutinise trades until more robust structures are commonplace. The activities of many traders is relatively opaque, and this is a real problem for originating bankers on the frontline trying to get some deals through their credit procedures. Onboarding new clients for many banks will be a rarity, and the financing of smaller oil traders in such a volatile market could be a complete no-go. Unsurprisingly there has definitely been a ‘flight to safety’ by many commodity financiers. 

Vitol case worries banks 

In another bad news story for the commodity sector, in early December, Vitol, the world’s biggest independent oil trader, agreed to pay $164 million to authorities in the US and Brazil as it admitted bribery to secure contracts. The trading group admitted to paying bribes in Brazil, Ecuador and Mexico over 15 years to gain an edge against competitors and secure contracts in a criminal settlement with the US Department of Justice. Vitol also settled civil charges brought by the US Commodity Futures Trading Commission (CFTC) alleging that it attempted to manipulate two S&P Global Platts physical oil benchmarks in 2014 and 2015. 

At the time, Russell Hardy, CEO of Vitol said: “Vitol is committed to upholding the law and does not tolerate corruption or illegal business practices. As recognised by the authorities, Vitol has cooperated extensively throughout this process. We understand the seriousness of this matter and are pleased it has been resolved. We will continue to enhance our procedures and controls in line with best practice.”

This case is also one that has implications for the banks that finance traders. Speaking with one banker from an international commodity bank that finances Vitol, it was clear that internal questions were being asked by compliance and credit as to why the bank should continue with such lending when there could be reputational damage for the bank. Coming not long after the damage from Singapore for that bank, the Vitol case was another painful blow for that bank to take. Internal pressures are immense in such institutions. 

But it has to be said that global trading companies are just that – big, complex and covering numerous jurisdictions, and not all activity that takes place globally within some entities is sanctioned by the company board. But transparency of activity is something that all traders need to improve on - for reputational integrity and to ensure relationships with lenders are maintained within a positive and sustainable framework.  

Digitisation of commodity trade

There is much more that financiers could do to ensure that deals are more tightly structured, with increased covenants, guaranteed collateral in place and also taking the next big step in moving to the greater digitisation of documentation. With so much damage having taken place in the Singaporean commodity sector, some critics believe the city state's monitoring and enforcement of many of the country's numerous privately owned trading firms in the energy sector are too weak. But changes are certainly coming as banks work with regulators to put a more robust framework in place. 

Globally, to date digitisation of documents and trades within commodity finance has been taking place at a snail’s pace. The duplication of paper documents such as bills of lading and title to goods is a real concern and is seen in many commodity fraud cases. It ought to be an outright priority that the regulators, legal profession, banks and alternative financiers, together with commodity traders push forward to put in place electronic documentation and systems that are robust enough to prevent some of the outright frauds that have taken place in the sector.

With all the scandals that have rocked Singapore this year, in early November the country’s trade minister, Chan Chun Sing said: “We want to uplift standards for the commodities trading industry to increase banking confidence in the industry.” He tamely noted there had been “isolated cases of mismanagement and defaults” that had reduced banks’ willingness to provide financing to commodity-trading firms. He said the city-state was partnering with the industry to develop a new code of practice for commodity financing and was also working on a digital trade finance registry (TFR). 

DBS and Standard Chartered have jointly led a group of 12 other banks to create and conduct this digital TFR proof-of-concept to enhance lending practices and improve transparency in commodity trade. Supported by Enterprise Singapore and endorsed by the Association Banks of Singapore (ABS), the TFR aims to be an industry utility by serving as a secure central database for the banking industry to access records of trade transactions financed across banks in Singapore.  

The group says this mitigates against duplicate financing from different bank lenders for the same trade inventory. Participating banks are ABN Amro, ANZ, CIMB, Deutsche Bank, ICICI, Lloyds, Maybank, Natixis, OCBC, Rabobank, SMBC and UOB. Following the completion of the proof-of-concept, DBS and Standard Chartered will work with ABS to implement the TFR as an industry utility, before expanding it globally. ABS will manage the TFR, supported by a standing committee represented by the ABS council member banks.

Then in late November, the first code of best practices for commodity financing in Singapore was launched. The Code of Best Practices for Commodity Financing was launched by the Association of Banks in Singapore (ABS), with the support of the Monetary Authority of Singapore (MAS), Enterprise Singapore, and the Accounting and Corporate Regulatory Authority. It lays out key principles governing prudent commodity trade financing practices. 

One of the two key themes underpinning the code is, at a macro level, banks should understand traders' corporate governance, risk management practices, business and transactions through due diligence and policy requirements. The other is, at a transactional level, banks should obtain sufficient transparency and control over financed transactions, goods and receivables.  

The code was developed by an industry working group of 28 banks, in consultation with trading firms. These lenders - including DBS, OCBC, UOB, Bank of China, HSBC, Citi, ABN Amro, BNP Paribas and SG - represent the majority of commodity financing banks in Singapore. Samuel Tsien, ABS chairman and OCBC group chief executive officer, said the code: "ensures a more robust and disciplined financing approach to support the growth of Singapore's thriving commodity trading sector". 

These measures and tools are much needed and overdue. The commodity finance sector needs a good period of stability following some of the hits it has experienced this year. Like a forest where a tree falls that space is eventually populated by others, and so the same applies in the finance sector. Coming out of the Covid pandemic in the second half of 2021 business and industry will pick up markedly and it is going to require financiers who know the markets to service a rapidly expanding and evolving commodity cycle.