Sarah Rundell discusses the growth of commodity traders in Africa as local and international houses see new opportunities and edge further into the continent.
When African agricultural commodity trading company Export Trading Group (ETG) first started importing India’s Mahindra brand farm machinery into southern Africa it sold mostly simple implements like ploughs. Today the Dar-es-Salaam-headquartered group reports most demand from its farming customers is for tractors. “Our business is changing with the uplift in personal incomes on the continent,” enthuses Johannesburg-based Jean Craven, head of corporate finance at the group and a seasoned commodity professional. “Farmers are importing fertilisers and pesticides too. In the past, opportunity centred on exporting African resources to overseas consumers but there is a consumer story in Africa now too,” he says in reference to how the continent’s accelerating economic growth, driven by fast-growing populations, stability and investment, is creating local demand for commodity imports spanning fuels to processed foods. It is a welcome flipside to cooling Chinese demand for African exports, and no surprise that the world’s biggest trading companies are jostling to benefit.
Switzerland, the world’s biggest centre for commodity trading companies, is home to trading giants like Vitol, which, according to its website, had sales totalling US$307bn in 2013, and Glencore, whose 2013 sales topped US$233bn. Others include Trafigura and Louis Dreyfus, and American giants Archer Daniels Midland (ADM), and the world’s biggest agricultural commodity trader Cargill. All have grown hugely successful on strategies characterised by controlling whole supply chains. These groups own everything from oil platforms to mines and farms, the ships and pipelines that carry the commodities, the silos and ports that store them and the plants that process them. Although many of them have been active in Africa for decades, much of their activity has centred on financing cargoes: delivering goods to port rather than venturing inland.
Now they are applying their integrated business model to Africa, grabbing more of the value chain with big-ticket investments such as Glencore’s 2012 US$300mn investment in Chad’s oilfields, Cargill’s plan to invest in a plant processing starch and sweeteners from local cassava in a staple crop processing zone in Nigeria and Louis Dreyfus’ partnership with a South African group to produce rice for local consumers.
Trading houses’ appetite for African growth is most apparent in Africa’s fuel products market, forecast to grow 40% by 2020 with countries like Kenya and Nigeria leading the way, according to Ecobank. African countries have made slow progress in building their own refineries, leaving them dependent on imported fuels and traders to source and deliver them. Trafigura and Vitol have snapped up the service station and storage networks being sold off by oil majors like BP and Royal Dutch Shell as they ditch downstream assets, and are now extending their reach to landlocked interior countries such as Uganda, Burundi, Rwanda and Tanzania, which import 100% of their refined product consumption. “It is as a destination market that these groups really see an opportunity because they can fill gaps in the Africa value chain,” says Professor Craig Pirrong, director for the Global Energy Management Institute at the Bauer College of Business, part of the University of Houston.
Addressing the demand
Trading companies’ push into Africa has coincided with many of the biggest Western banks disappearing from physical commodity trading and trade finance. Tighter regulation and capital constraints, such as know-your-customer and other compliance issues have brought new complexity and costs for banks: US sanctions policy and the penalty for getting it wrong for heavily-fined BNP Paribas has further doused enthusiasm for often risky African trade finance among Western banks, particularly for longer-term transactions. Commodities trading revenue for 10 of the world’s biggest banks has fallen to US$4.5bn, down from more than US$14bn in 2008, according to London-based consultancy Coalition. Former industry stalwarts have fled the industry, leaving commodity firms to snap up their businesses: Mercuria, a 10-year old Switzerland-based trading firm, bought JP Morgan’s physical commodity unit a year ago.
Of course, international banks still have an appetite to finance the continent’s flagship deals from borrowers such as Angola’s state-owned oil producer Sonangol and Ghana’s Cocobod, and new Middle East, Asian and local African lenders are financing more African trade than ever before. However as Edward George, head of group research at Ecobank in London explains, the climate has changed: “In short, the banks have backed off. When they look at these deals from a compliance side they realise they can’t do them.” Cue the entrance of commodity trading houses, now key providers of credit and pre-payment facilities, with some beginning to offer hedging solutions or even putting together structured deals for their clients.
But although many banks may have lost their appetite to finance trade directly, they are prepared to lend to the big houses. Last year Glencore signed a jumbo US$15.3bn revolving credit facility backed by 69 banks in a deal that illustrates that banks are still keen for trade exposure, as long as someone else shoulders the complexity and risks in regions like Africa. Going forward, however, trading houses may increasingly struggle to raise finance from European banks, warns Pirrong. “One of the major risks to their business is that it is capital intensive. There is less money available than there used to be and commodity trading houses are quite reliant on European banks,” he says.
Shedding light on regulation
The size and ever-expanding role of trading houses is starting to ring alarm bells among pressure groups pushing for greater regulatory scrutiny. Criticism that trading houses had become ‘shadow banks’ because of the financial services they offer suppliers grew after Glencore last year organised a US$1bn-plus loan to allow Chad’s state-owned company Société des Hydrocarbures du Tchad (SHT) to buy Chevron oil assets in the country.
Stock market listings and public debt issuance have provided greater insight into operations and performance at Glencore and Trafigura, but many trading houses are privately owned and do not disclose detailed financial results. Critics are now asking why they are exempt from the regulatory capital requirements of banks and calling for much tougher rules on transparency. A recent survey by NGO National Resource Governance Institute (NRGI) highlighted the extent of Swiss-based trading companies’ dominance in Africa’s oil sector, where they have grown to become the largest buyers of oil from the governments of Cameroon, Chad, Equatorial Guinea, Gabon and Nigeria, it says.
Glencore bought all of Chad’s government-owned oil, making payments estimated to equal 16% of total government revenue in 2013. “These transactions are of major importance to these local economies but only a handful of people in the country understand how they work. These companies are engaging in countries in ways that have serious implications but deals are subject to remarkably low levels of oversight,” says NRGI report co-author New York-based Alexandra Gillies. “These companies have engaged in diverse relationships with African governments whereby they will provide finance, buy oil, or invest upstream as producers in joint ventures with government agencies. There is a real flexibility to their model but all aspects of the relationship need to be understood to tell whether a country is getting a good deal,” she says. Last year Mukhisa Kituyi, secretary general of the United Nation Conference on Trade and Development, UNCTAD, raised the regulatory temperature when he referred to “the mounting allegations of large-scale trade mispricing by Swiss-based commodity trading companies, which operate in developing countries”. The challenge now, says Pirrong, is “for firms to find a middle ground between opacity and a completely open window”.
Expanding into Africa brings a new level of risk to commodity trading houses. “Moving goods around Africa is still difficult and government interference is always a problem,” says Craven. “These groups may deliver goods to the port but we’re still not seeing them prepared to take them inland – we have the strongest risk appetite for this,” he says, listing a gauntlet of hurdles from sudden import and export bans, to governments introducing ceiling and floor prices in staples like wheat, sugar or maize and playing havoc with the market. “Zimbabwe, Zambia, Malawi – these countries are the regular culprits,” he warns. Ecobank’s George believes that the big trading companies will reduce risk by only venturing up the supply chain “as far as they need to”, leaving valuable niches to successful and trusted local players.
In Nigeria, local oil trading groups are adding to the competition. Taleveras trades over 100 million barrels of crude oil annually as well as several million tonnes of gasoline, LPG and jet fuel. Entrepreneur Tonye Cole’s Sahara Group and Ontario Oil & Gas, which exports approximately 2 million barrels of Nigerian crude oil per month as well as importing refined products, are also national champions aided and abetted by government policy to increase the role played by local firms in operating oil blocks and trading. “In Nigeria there has been a notable shift towards indigenous companies,” says Pirrong.
In another development, a giant project will ultimately reduce Nigerian fuel imports and compete with the trading companies. After decades of government neglect of the refining sector, businessman Aliko Dangote has taken matters into his own hands. Africa’s best-known businessman is building a refinery outside Lagos to provide the local market with fuel products with the target of doubling Nigeria’s existing refining capacity which currently only meets around 20% of the country’s fuel needs.
Competition for the trading houses is also coming from the big commodity consumers, such as Unilever, now wrestling for more control of their supply chains and actively trading themselves. More Chinese companies are also building up their own trading businesses that can source foodstuffs from a broader network of suppliers.
Over the last decade, commodity trading houses have grown into huge, vertically-integrated supply chain managers. But the commodities supercyle has slowed on cooling Chinese demand and the prospect of tighter regulatory oversight will make the business climate tougher. Investing in Africa comes with more risk than most regions but these groups, which thrive on volatility, have an eye on the continent’s new consumers. “There is no sign of shifting strategies yet,” says Pirrong.