Monday 28 September 2015

Glencore: Enron Mk2?

What comes to mind when the share price of a monster commodities trader falls off the edge?  Enron, that's what.

For readers too young to remember, Enron rose from being a near-bankrupt US gas pipeline company in the mid 1980's to becoming the pre-eminent market-maker in energy and a host of other commodities in less than 15 years, at the same time as forcing through market liberalisation in gas and power across most of the western world (with every man's hand turned against them, which makes the achievement all the more remarkable), going on to revolutionise the markets for coal and paper+pulp, and developing Enron Online, the biggest B2B platform the world has known.  And there have been 14 years since it went under!

But under it went, and the reason was the oldest in the book: under-capitalisation, with profits way, way ahead of cash-flow.  (Yes, many of the more lurid Enron stories were true; and yes, they had laid waste to the Californian electricity "market"; and yes, the CFO had his fingers in the till - but none of these alters that basic, simple underying fact:  under-capitalisation.)

I know *ahem* a lot about Enron and nothing in the same detail about Glencore.  But I recognize an over-extended trading shop when I see one.  Enron's demise caused a lot of dominos to fall (in strikingly slow-motion, as I recounted here), including carnage in the banking sector; and there must be a decent chance the same will happen now.  Anglo American is being mentioned in same breath as Glencore and one strongly suspects that a few more Swiss-based firms will be under pressure.

Could a Glencore melt-down (which hasn't happened yet) be as bad as Enron's back in 2001?  Glencore per se is a lot less commercially significant than was Enron that time.  However, the global financial situation is a lot less robust now.  In 2001, the great restructuring houses were fresh from their exploits in the Asian crisis of 1997-8, and were certainly up for fixing the energy sector's woes without too many widows and orphans feeling the pinch (beyond the families directly impacted in the failing energy merchants  -  why are American employees allowed, nay encouraged, to invest their pensions in the shares of their employer?!)  Even British Energy, a very awkward casualty in the protracted aftermath, was put back on its feet without there ever being much risk insolvency would cause its reactors to pop from neglect.

Falling dominos this time around may hit the ground with a thump, and find no medics on hand to resuscitate them.



Sackerson said...

Very interesting, ND. Not sure I see this sort of technical analysis in the MSM.

Nick Drew said...

thanks Sackers

memories are short, journalists are young (and getting younger, as the salaries and numbers are slashed), ignorance and superficiality are rife, there's little appetite for real research

and on a good day 20 years ago it was rare for even the FT or the Economist to conduct genuinely probing market analysis (none of them saw Enron coming - or going - for example, much as they bewailed their own failures after the event)

they all have advertising revenues to consider

also I think there is some caution around saying much abt big ugly players like Glencore (and some even uglier ones in the same neck of the woods): you can always have a go at politicians and they rarely feel able to hit back: but businesses are more prone to getting the lawyers out

but we are fearless! (only kidding)

Anonymous said...

".. some even uglier ones " - Trafigura peut-etre?

DtP said...

When they merged it always seemed a bit bonkers as the execs got a frikkin' fortune and I think they kept the Chief Exec on after he'd been paid an absolute mint. Obviously, not being sooper minted myself but you'd have to dig deep to find any morivation to turn up on the Monday morning when your bank account is bulging. It appeared that the Board started acting for the Board not the company.

Anonymous said...

Don't know much about Enron but Marconi also sank without trace and I had some shares as my father had worked for Plessey later taken over by Marconi. I thought it must be "a good company" and it's shares were tipped in MSM weeks before it went under. What do I know? I lost the few bob "invested" and I haven't touched the stockmarket since.

Demetrius said...

The latest "Private Eye" has a long item on Glencore.

CityUnslicker said...

Why on earth they bought Xtrata at the top of the market will be what comes back to haunt them.

Doubt the Yanks will let it go down though...too Lehman-esque.

Anonymous said...

There are a few Lehman employees who have changed careers. They are now in the HoC overseeing banking and other regulation.

Who better to understand how to shaft the system.

James Higham said...

Under-capitalization and profit sound a lot to me like greed.

Nick Drew said...

depends when you get out, James!

plenty of the Enron types, including some of those at the very top, didn't cash up in time

andrew said...

I thought enron fell due to just one too many slightly dodgy but individually legal off balance sheet manipulations that taken all together gave a completely false picture of the company's finances
- and running out of money pushed them over the edge?

Nick Drew said...

andrew - they were always out of money:

(1) only ever borderline investment grade: and staying IG is 100% necessary to do derivatives and long-term deals, which were the key profit-earners

(2) taking MTM profits (entirely legitimate) on very long-term deals - great for the bottom line + share price but does nothing for cash-flow

(3) expanding like crazy (10-15%) for year after year after year, which exacerbated the situation

(4) no-one willing to call a halt to growth for a period of consolidation, because it was a 'growth stock'

So - the growing gap between profits and cash couldn't be bridged by borrowing. "Individually legal off balance sheet manipulations is corrrect - some of the cleverest securitisations ever seen, the banks were gobsmacked by the creativity of what Enron was inviting them to buy into, gaining access to AAA funds in ways that were pretty smart, and (to start with) entirely legitimate, legally and *economically*

and yes, eventually they ran out of road; the cash-gap got bigger; the financing deals necessarily got flakier (all the while with banks clamouring to participate!!); the pretence couldn't be maintained, and - splat

Lesson: to be a market-maker you need AA credit-rating, and the capital that goes with it! It's a capital-intensive business: traditionally in terms of steel & concrete or, if you are doing energy the Enron way ("asset-lite"), risk-capital

here endeth the first lesson - the first and always the most important

Anonymous said...

How much money did Glencore insiders make at float time? Looks like a case of greater mug theory?

BTW what does CU think about an EMED dabble at 3.5p - or is that unprintable?

Steven_L said...

The way I see it, UK pension savers are basically being fleeced as they tend to more or less track the FTSE - which is ridden with these commodities firms that appear to just nick money from their shareholders.

Look at FTSE all share performance against the S&P500, or FTSE100 against DJIA.