Mineral Trading


1. Context

Mineral trading has been curiously overlooked in the world of resource governance. While most other stages of the value chain have for years now been subject to scrutiny, trading has only just entered the scope of agencies concerned with how natural resources are managed. There are a number of reasons for this, but perhaps the most significant has been the assumption that since trading takes place on intensely competitive and highly visible global markets, potential “weak links”, points at which governance could go wrong, were somewhat limited.

But this rests on two assumptions. First, that commodities markets are relatively straightforward to understand, with simple and known pricing systems. Second, that most commodities are in fact traded in this way, on the open market.

The fact is that, although both assumptions hold enough truth to be valid generalisations, there are many qualifying factors to this picture.

First, although commodity trading uses benchmarks whose prices are freely quoted, such benchmarks are reference points rather than absolute controls. A host of considerations such as the relative grade of the commodity being sold to the benchmark, location, need to be factored in to a final price of a commodity being sold in a “spot” market. Then there is the fact that in addition to the spot market, we have futures, swaps, options - and a whole range of financial “derivatives” based on underlying physical commodities, before we get to the fact that digital trading may be making markets less, rather than more, transparent.

Second, nobody knows precisely, but it is clear that a large, and perhaps growing, proportion of the world’s commodities are not traded on open market at all. In the case of oil, for example, US government figures show that in 2002 some 24 percent of imports were “related party transactions”, trades whose terms were controlled by parties that belonged to the same business group. By 2013 this figure had risen to 43 percent, in the largest oil importing country in the world. In minerals, the rise of China as “swing consumer” has been accompanied by Chinese acquisition of assets at all stages in the value chain, also leading to a growing number of transactions which never make it onto major trading exchanges.

We may therefore better frame trading as the broader question of valuation: how are commodities valued, and then price.

Commodities markets have become more complex in recent years as a result of a number of factors. One is huge growth in both supply and demand since the year 2000. According to The Economist, leading countries consumed 50% more tin in 2011 than at the turn of the century, 60% more nickel, 60% more lead, 60% more coal, 40% more zinc, 30% more copper and 20% more silver and gold. Iron ore production has nearly tripled in that time. A billion tonnes more are produced today than at the end of the 20th century.

Part of this can be explained by the world's rising population — there are an­other billion people alive on the planet since the year 2000. Another part of it is rising living standards, as parts of what used to be called the developing world rush towards prosperity.

 
   

 

China's rise as global "swing consumer" of a number of commodities has been stunningly fast. Twenty years ago, it bought eight percent of iron ore traded on world markets.

 

Now it is 60%. Across metals as a whole, its share has risen from 3% to 30%.

 
   

There are also more mining companies on the scene now. Rising demand has led "junior" less capitalised companies into more remote and harsher locations in more speculative exploration, where they may seek quicker returns. Other companies may be large but new to the international scene, lured out of national strongholds by crazy demand and prices.

Not surprisingly, in this environment of global demand and supply explosion, prices, straddling the two, have been volatile. Prices for most commodities including oil and gas shot up from 2000 until around 2011-12 for many commodities, and 2014 for oil and gas, when they dropped sharply.

And just as production and consumption shot up, so did speculative investment in financial instruments around commodities. The United Nations estimates the number of commodity futures contracts traded more than doubled every year from 2001 to 2011 as a slew of commodity trading indexes sprang up. The role of this "financialisation" is hotly disputed. Some say it has driven the price rises, others say it has pro­vided liquidity at a time of unprecedented growth in demand. But it is unlikely to go away.

The last decade has also seen the rise of significant “high frequency trading” - trading by algorithm. The precise extent of it in commodities is not known, and in fact cannot be known, but there is no reason not to suppose that commodities trading is subject to the same features of trading gamed by the nanosecond (billionth of a second), as other financial markets. There has certainly been a fracturing of trading exchanges, with the Economist reporting that over 60 now exist around the world, considerably more than a decade ago, and London, New York and Chicago no longer dominate global spot trade like they once did.

But some features of the trade endure. By comparison to trading in bonds, or even most stocks, commodities remain higher risk, for example: they pay no dividends, require physical storage solutions, and suffer from greater political risk.

Different estimates exist for the global size of the trade, from $2.5 trillion to $3.8 trillion. Because the sums involved are so high, project finance and insurance are large industries in their own right, and apply not only to commodities themselves but to the pipelines, ships, and storage tanks that facilitate their entry into market.

2. Potted history of commodity trading

For a long time in human history, money was itself a physical commodity, since most coins were made out of one of gold, silver or bronze, and commodities have been traded for as long as they have been refined. Trade in such commodities was a key part of many empires, and in fact historians now believe many of the economic aspects of what is today known as Resource Curse might have been present in sixteenth century Spain - a drop in productivity in traditional li­velihoods, corruption, political and social stagnation and conflict - because of the influx of gold from the New World.

The first modern commodities exchange was in Amsterdam in the seventeenth century. The Royal Exchange in London dated back earlier, but was not formalised as the London Metal Exchange until the nineteenth century, which is also when US markets such as the Chicago Board of Trade, and the New York Mercantile Exchange came into being.

Such exchanges were devoted to trade in “soft” commodities, such as sugar, wheat and coffee, and metals, such as gold, silver, iron and so on. By contrast, it took about a century after oil started to be produced before significant quantities of it were traded on the open market. Internationally, the oil industry was developed and dominated by the companies known as the “Seven Sisters” - Anglo-Persian Oil Company (now BP), Gulf Oil, Standard Oil of California (now Chevron), Texaco (later merged with Chevron), Royal Dutch Shell, Standard Oil of New Jersey (Esso/Exxon), and Standard Oil Company of New York (now trading as Mobil as part of ExxonMobil). All these companies were vertically integrated, meaning they took the oil they produced in the upstream and put it into their own refineries, where they produced the end products that their chains of gas stations sold to the public. Such was the control exercised by these companies that in the case of Iraq, for example, oil production was kept deliberately low by the Iraq Petroleum Company, made up among others of the Anglo-Persian Oil Company, Royal Dutch/Shell and Standard Oil, in order to maintain prices in the companies’ home markets.

This situation did not really fundamentally change until the late 1960s and early 1970s, when Glencore, a company set up by traders who had previously worked for Philipps Brothers, began to trade oil out of the Middle East. The growing impulse for national control over oil industries also underpinned this development, as governments and newly formed state oil companies looked for more options to sell their resources.

The turbulence of the Arab oil embargo and the rise of OPEC as another producer cartel led to diversification of production - which reinforced the drive towards an open market again.

If patterns of trading in oil and minerals were radically different in history, they have converged in the last few decades. Both have seen waves of financialisation, beginning in the 1980s. And while there are differences in the way certain minerals are traded, the commonalities predominate.