Glencore / Commodities Update: It's Serious

Source:  FT

The Glencore story is developing fast and there's spin aplenty in the air.  The company, and others of the commodities fraternity like Trafigura, wish it to be known that (a) they are nicely diversified and (b) there's no great Systemic Risk here:  "here are some arguments as to why commodities trading firms do not pose systemic risks".  Move along, everyone.

Well (c) Glencore may be diversified but the market sees it as a natural physical long position, and is treating it thus; and (d) whatever else, some of the firms we know about (i.e. the publicly held ones) look pretty under-capitalised - don't they ?!  Actually, very under-capitalised.

The oldest problem.  And that takes us back to Enron. 

Now look at the percentage of the FTSE that is represented by commodities firms of one sort or another (and see Stephen L's comment on pensions in the earlier post linked above).  Systemic risk?  O-oh yes.

ND

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.

ND

Will Glencore be the new Lastminute.com?

Glencore, a huge secretive partnership that controls much of the world's commodity trade, has had an embarrassing few weeks as it looks to do an IPO that has a sole reason of making its staff billionaires and millionaires. They don't say this, but the IPO papers put together don't have much of a story to tell as to why they need all this external investor money.

Of more interest, is the sell-off in the commodity markets of this week. They had been on a big bull run so these things always correct, but the sell -off is sharp.

One is reminded strongly of former top of the market deals, RBS buying ABN AMRO and Lastminute.com listing in the hype of the internet boom - and this is just UK deals. in the US you have AOL-Time Warner the daddy of all bad deals.

Glencore is yet to hit the market, but the joie de vie is draining fast. Glencore's float will be stage managed (by underselling to tracker funds, the initial price will be at the low end of the range etc) to make it go up on its first day - but when we look back in a year's time - will we see this as the moment of hubris?