World economy has been facing a global slowdown since the start of 2014. Majority of the economies, leaving out a few emerging economies, have so far bottomed out in terms of their GDP growth numbers in the recent quarters. The most significant signs of the global meltdown are the recent fall in global commodity prices amidst subdued global demand and peak volatility in energy prices. The fall in the commodity prices has been beneficial for countries who are net importers of these commodities but have severely dented a few Oil producing nations and oil marketing companies. We witnessed, Saudi, Yemen, Russia, and other OPEC nations selling off oil at prices as low as $44/barrel leading to tensed economic conditions. But there were few companies and countries which were probably ignored because of their strong reputation. One of them is Glencore Plc. In this blog, we will talk about Glencore, its business dynamics and the glitch that might cause a serious threat to the global economy.
Before we proceed, let me brief the readers about the background of the company. Glencore Plc (Glencore), the Global Energy Commodity Resource, a multinational giant in commodity trading and mining. It is probably the largest company in Switzerland and the world’s largest commodity trading company. It facilitates trades of various commodities such as zinc, copper, grains, oil etc.
Going back to 2013, we witnessed the global oil prices started tumbling from $110 / barrel to an average price of $50 / barrel. Similarly, the copper prices also started tumbling in the recent year with the fear of weak demand and oversupply amidst Chinese slowdown. The above image show the trading share of Glencore. The image given below give a brief idea on how the revenues share is dependent on these tumbling commodities.
Is anything fundamentally wrong with Glencore? Was it considered a debt burdened company before although having the same levels of debt? The answer is no. It is a levered bet on not only china but on the fate of copper and oil prices in the near future. Lets focus on what has happened in the recent past. With the falling commodity prices since the last 18 months, amidst China slowdown, Glencore has been a counter-party with China in Chinese Copper Financing Deals. The Chinese traders have been using copper as a tool for carry trade by creating artificial demand. The following image will give a brief idea of carry trade on copper.
Precisely, China is creating 70% of the demand artificially by selling off copper and taking positions in futures market to buy it back after 13 months. On paper the demand is definitely existing but it might happen that the same contracts are rolled over. This might make Glencore’s position weak since the contracts are existent but the actual cash flows might be deferred for a longer period. With this fear, two rating agencies namely Moody’s and S&P downgraded Glencore’s rating to BBB with a negative outlook. The BBB rating with a negative outlook is just a notch above the non investment grade rating. The results have dented its share prices in the past few months. As a corrective action on the entire situation, it announced a dramatic recapitalization plan, one which would see it not only scramble to raise $10 billion in capital through an equity offering, asset sale and capex cut, but become the first major copper supplier of scale to cut production and indirectly benefiting its biggest competitors. Apart from the copper, various other commodities and major currencies have witnessed turmoil and it is unlikely that Glencore will be decoupled from the effects of the same. Here’s a snapshot of Effect on EBIT vs Sensitivity of Various parameters.
To sum up, with the commodity prices heading southwards it seems difficult for Glencore to recover. Although, they are trying to raise fresh capital and reduce their debt with the same, it is unlikely that they can control the external events predominantly related to the Chinese economy. In the midst of the events stated above, questions are being raised about the solvency of Glencore. What if Glencore fails to sustain the further fall in commodity prices? Well, since Glencore is not just a miner but probably the world’s largest commodity trading desk, and a key commodity counter-party, especially in Chinese carry trade deals, the answer is probably simple – Glencore might turn out to be a Lehman Brothers, only this time in the commodity space.
Thank you. 🙂