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Commodity traders are increasingly leaning on strong balance sheets and sector expertise to provide pre-payment and early-stage financing to mining and energy projects, research by McKinsey finds. 

Larger traders generated unprecedented returns in 2022 and 2023 during a period of intense market volatility, but have since seen margins compressed in a “more nuanced market environment”, the consultancy says in a report published this week. 

With supply currently meeting demand comfortably for many commodities, notably battery metals such as nickel and lithium, prices have trended downwards and shown less volatility, it says. 

Facing smaller margins, McKinsey finds traders are increasingly looking to maximise value from existing assets, including by using their strong financial position to secure longer-term access to commodities. 

“Some incumbent traders successfully protected access to in-demand nonferrous metals such as copper and lithium by locking in long-term contracts with miners and metals processors, offering pre-financing and investing in critical logistics assets,” the report says. 

In the oil market, traders “are uniquely positioned to provide early-stage financing for greenfield and brownfield ventures”, it adds. 

“Unlike banks and other lenders, traders can leverage their market access to offset the risk of default. Sophisticated trading houses are already leveraging their balance sheets to lock in access to in-demand commodities.” 

Joscha Schabram, a partner at McKinsey in Zurich and co-author of the report, says this trend partly stems from banks being wary of the credit and country risk associated with financing long-term projects. 

“Especially on the mining side, but also the oil and gas side, more and more of this financing is provided by the commodity traders… with the equity and cash that they have generated,” he tells GTR. 

“That’s where commodity traders can have an advantage over banks in managing the credit risk, because they are the physical off-taker.” 

Typically, under such arrangements, a trader will provide upfront capital to support a mining or energy project in exchange for access to commodities extracted or produced at a later date. 

These structures can also provide working capital for smaller and mid-sized traders that have struggled to obtain traditional trade finance or working capital facilities from banks in recent years. 

McKinsey says junior miners and smaller oil companies can use such relationships to benefit from the market access and expertise provided by larger players. Those larger players, in turn, can expand their origination strategies and access materials “often at discounted prices”. 

“There is an opportunity for a broader set of firms to partner with smaller players, especially for commodities that are thinly traded and limited in supply,” the report says. 

 

Volatility ahead 

The findings come as trading houses traditionally focused on energy are rapidly growing their metals desks, bringing in high-profile traders from rival firms. 

Although currently stable, supply of critical minerals such as copper, lithium, nickel and rare earth elements is expected to fall well short of demand over the next decade, previous McKinsey research has found. 

Industry experts believe that imbalanced supply and demand – as well as looming geopolitical tensions and the possibility of technological developments – mean another period of volatility likely lies ahead. 

“There are so many unknowns, and I think there will be boom and bust cycles,” Schabram says. “That would be a major factor for commodity traders, because that volatility basically correlates with their returns.” 

“That also has implications for the financing industry, because if we see that volatility, it means we’ll be seeing more credit risk, and more need for collateralisation with large margin swings.” 

The McKinsey report says traders can prepare for this scenario by using the current period of relative calm to develop more efficient operating structures and lower their overhead costs, while accruing trading acumen. 

A leaner model could produce cost efficiencies of US$1.5bn per year across the industry, McKinsey says. 

It also calls on commodity traders to grow partnerships with technology firms, which are increasingly acting as “critical partners to identify and access new trading strategies”, for instance by providing insights into market data or understanding trade flows in nascent markets. 

“Commodity traders have been slower than other industries to digitalise processes and adopt new workflow tools, yet our research shows realizing these business efficiencies could eliminate more than US$5bn in costs across the industry,” the report says. 

Schabram adds: “There was just no time in the last two or three years to think about operational efficiency. Now that the margins are more compressed, there is a high incentive to control your cost and bring it down.”