Odd Lots - Javier Blas Explains How Commodity Trading Shops Really Work

Episode Date: May 2, 2022

One of the big themes these days is the return of the 'real' economy. You can't solve problems these days with just money. Not everything can be done by sitting behind a screen. And so some of the most important players in this new environment are the commodity trading shops, which help arrange financing and delivery of oil, coal, natural gas, nickel and everything else you can think of across the far-flung corners of the globe. It's a very different type of business than most trading, which is mostly just about charts on a screen. On this episode we speak with long-time commodities journalist turned Bloomberg Opinion columnist Javier Blas -- the co-author of 'The World For Sale: Money, Power, and the Traders Who Barter the Earth's Resources' -- to get a deeper understanding of how these firms operate, and how they're dealing with this environment of surging commodity prices and extreme volatility. See omnystudio.com/listener for privacy information.

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I'm Tracy Allo. And I'm Joe Wisenthal. Joe, big news today from Europe, which is that Russia is cutting off supplies of gas to countries, Poland and Bulgaria, specifically, that refuse to pay in rubles. And, you know, this is something that has sort of been expected in some sense. But lots of people are viewing this as the beginning. of the weaponization of commodities. Yeah, and it fits with, you know, a theme, obviously, we've talked about several times,

which is this sort of, I guess there's two things. I mean, on some level, it's like this fracturing of the commodity supply chain trade routes changing, but then also the changing nature of like the financing side of commodities. And so the idea that, okay, you can buy the same commodities, but you have to do it differently in a different currency. see, you know, this fundamentally is beginning to shift just the way commodities are paid for and financed.

Right. So this is a point that I think a number of our guests at this point have made. So Zoltan Pozar, Pierre Anderon, Jeff Curry. If countries aren't importing Russian gas anymore or oil, they need to find that from somewhere else. And simultaneously, it means Russian gas and oil might be going elsewhere, like to China, to the east. And all of that rerouting is going to take. additional money. And we've seen lots of players in the commodities talk about this. They've talked

not only about the upfront costs of transportation of commodities, but they've also talked about what all of this means for the market itself. And we've seen intense amounts of volatility, which to some extent mean that the commodities traders are making loads of money, but on the other hand, they are having to deal with this volatility, and it can disrupt their business. Right. And of course, and, you know, this is obviously, and you mentioned it's something that Zoltan has been talking a lot about. But, you know, all these trades are financed. There's leverage involved.

There's borrowing. And when you have a really big jump in volatility, then, of course, financing gets more expensive. You have to put up more collateral. You get margin calls, things like that. Also add in the complications of, you know, some banks have been sanctioned. And you can't deal with some institutions. So the financing side of all these trades just gets much. more costly and complex. Yeah, and it's not exactly as if it was transparent to begin with,

and now it's just become even murkier in some respects. So today, I am very pleased to say we are going to be digging into the financing side of commodities trading, and we really do have the perfect person to talk about it with. We're going to be speaking with Javier Blass. He is, of course, a Bloomberg opinion columnist, but he is also the author of The World for Sale, which is a book on the commodities trading houses, an excellent book on the commodities trading houses. So, again, the perfect guest. Havier, thank you so much for coming on all thoughts. Thank you for having me. I kind of, I'm sort of amazed we haven't done this sooner. You're one of the most requested guests on to it. People are always saying, what are you getting Javier? It's like, we're getting get around to it.

And then we ran into Javier in the newsroom. It's like, let's just do it right now. I think that is that my parents probably on Twitter reaching out to you. Good parents. we start, I guess, with the basics. I mean, sort of potted history of your book, but how did we wind up with a situation where we have all these independent commodities traders who are dealing with, you know, important goods, things like oil and gas that we depend on for transport and heating, food supply, vital strategic goods with seemingly not that much oversight? Well, yeah, you are absolutely right. We need the commodity traders because commodity traders, because commodity,

are not produced generally where they are consumed. So you need someone to take the risk of moving the staff from A to B. And that's the role that the physical commodity traders play. I mean, these are not guys who are betting on the futures market or the options market behind a screen. These are guys who go into upcountry, as we call it, a mining the DRC deep into Africa, Peru, oil fields in Iran, and they get the oil, they put in a tanker,

and they transport to the consuming markets, and they finance all that process. They deal with all the logistics, which are mind-blowingly complicated in some cases. You know, the main reason is because commodities are not produced where they are consumed, and they need someone to intermediate that risk. And that's quite a lot of risk. It's financial. It's logistics.

It's credit. It's operational. It's weather. It's risky in terms that, you know, some of these commodity traders are often operating on war zones, and you still need them to get to, get the commodities out, and they get pay very well for that service. Yeah, so when I think about like traders typically in my mind, you know, I imagine someone

looking at a screen and there's like, you know, one basis point difference between a 10-year treasury and a 10-year treasury futures and this find some way to like make a penny off of that. But when we're talking about commodities, we might be talking about equivalent barrel of oil moving out of Russia that's $60 cheaper than something, you know, a number. the same barrel of oil in continental Europe, and then someone, their job is to find a way to get that cheaper barrel of oil to someone who wants it. And if you can do that, that seems lucrative. Yeah, that's exactly what they do. At times that is very complicated because, well, you know, you are dealing with all those logistics, you are dealing with all that risk, and because you

actually have to put a lot of money at work. The size of the business, I mean, some of these companies, they have turnover of $300 billion, $400 billion a year, which is a mind-blowing number. And obviously, they don't have the profits equivalent to what Apple or Coca-Cola or Amazon will make if they were having those sales. But the size of the turnover is just amazing because of the volumes that they move. I mean, Vitor, which is the worst largest oil trader, moves enough oil to supply five or six of the largest European economies.

So it's not an easy business at the best of times. You just described it as really complex. What's it like in a moment like we've just experienced over the past month where we've seen intense volatility, we've had a drama with a particular commodities exchange over this volatility and canceling trades and things like that? What actually happens in a period of intense volatility for the commodities traders? Well, the first thing to understand, which is very important, is that physical commodity trading is a highly leveraged business.

These companies operate with thin equity, and they borrow money from banks. And these are not typically borrowing from Wall Street banks. They are borrowing money from commodity trade finance, which are the typical European bank where you may have a mortgage. Actually, my mortgage bank for my flat in London probably is a big financier of the commodity. trading houses. So these are not the big, they are not borrowing money from the likes of Goldman Sachs. They are just borrowing money from European commercial banks. So, sorry, just to be specific, like a BMP paraba, that sort of thing. Yeah, I mean, BNP Pariba was the largest lender to the industry. It just decided a few

years ago to shut down the business after they got involved in some bad case with the U.S. Department of Justice. But we are talking about the likes of society general of iron, G, Credit Suis, some unique credit of Italy, that kind of European banks. And, well, when commodity prices go through the roof, as has happened on recent days and weeks, two things happen for the commodity trading houses. First of all, they need to borrow a lot more money because a barrel of oil is more expensive. So if a barrel of oil a year ago was close to actually almost negative, but, you know, say that it was $25 and you were moving a million barrels of oil on a super tanker, you needed $25 million to borrow.

Today, at more than a hundred, it means that you need $100 million. So the borrowing needs have increased significantly. Also, because of all the volatility in the futures market, if you are hedging that operation on the futures market, you mean that you are long physical, you are short on the paper side. The price continues to go, so you are getting hit by margin calls. and those market calls could get very high. We have seen some commodity trading houses getting a billion dollars a day of additional

variation margin calls. And that combination has really put a lot of pressure on the finance of some of these companies. As I said, for the starting point, they don't have a lot of equity, and they rely on banks. And banks are really reaching the limits of how much money they can lend to them. What do you walk us through a trade? I mean, you know, you walk through some of the prices of oil on it. tanker, but it is the idea that, okay, there's some buyer who wants oil, there's some seller

halfway around the world, and then the trading house makes it happen, but to make it happen, they borrow, they don't want to put up their own money to transport that oil. They borrow for the duration, like, how long are they borrowing for? Are they revolving lines of credit? Like, walk us through a little bit more like how the trade works. They have all kinds of different borrowing facilities, from revolvings to bilateral deals, to just at all for a transaction. But a typical transaction right now will be buying Russian oil,

which is still legal if you are moving it into, say, the Netherlands. Rotterdam is the center of the European oil industry. So say that you are a trading house, Joe commodities incorporated, obviously, on a tax heaven, because all these companies are incorporated on some places like the British Virgin Islands and similar. And you are buying a million barrels of oil from Rosnev,

the Russian estate control company, you will have put, and that's going to cost you around $80 million because Ross Neff is selling a big discount to the market. You probably are going to put perhaps as little as $5 million of your own money

and you're going to go to a bank and you are going to borrow all the rest of the money. Then you will, at that moment, you own a million barrels of Russian oil, so you are long physical. You want to protect yourself

because you don't want to see a price drop hurting you. So you will take a short position on the futures market to make sure that you are hedge. Long physical, short paper, everything should be fine. And then you get a vessel, which is complicated because there are no many companies who want to go to a Rassian port to pick up the crude. You will have to deal with all the operational.

Sometimes there is bad weather and you cannot send the trip. So it gets complicated on that. Say that you get everything right, you get the oil into the tanker, and then you move it to Rotterdam, you try to discharge into a refinery. But in that period, just in mind that the price of oil goes from 100 to 150, you are going to be making, you are fine because you are hedge. But obviously, the margins, the exchange is going to start demanding significant variation margins

on that short position. And then you have this cash flow mismatch. You have not yet delivered the oil, so you have not really cash in your loan, physical position. At the same time, you're sure on the paper is massively underwater. You are getting the margin calls. So you are going to have to go to another bank and say, please, can you give me some money? Can I borrow you money because I need to pay to the exchange? When all of this is not just one tanker, but hundreds of tankers a day floating around and billions of dollars on borrowing is when it gets very difficult. And when some of the companies reach the limit or how

much they are borrowing from the banks. That is when the banks say, we cannot continue lending to you. And that's where we saw the lobby group of the European energy traders go to several central banks and saying, we are running out of liquidity. We have a big problem. Marking calls are effectively killing us. I want to get into this idea of whether or not central banks or governments should support commodities, trading and finance.

But before we do, one thing I've been wondering, given the volatility and given the types of margin calls that we've seen. Do people hedge more or less in this environment? Because you can kind of argue it either way, right? You know, you don't have as much credit, so everything you have is sort of just used up in the trade. Less can be used for the hedge. But on the other hand, there's so much volatility at the moment that you would want to make sure that you're hedged. I mean, this is the time that everyone should be hedged as well as they can, because the market is moving in huge price increases. I mean, we have seen brain crude a market that for many years

have never traded more than $30 or $40. We have seen price movements of $30 to $40 in the space of a week. You are not hedge. The market could kill you, but you are absolutely right. My suspicion is that a lot of the trading houses have reduced significantly the hedging just simply because they cannot afford it. which is extremely risky, and that's what could bring a company down. You know, I want to go back to something just in like the why of these companies.

And I, you know, just your explanation, it's like, look, the commodity is made somewhere. It's probably going to be consumed somewhere else. You need someone to take on the risks and the process of doing that. Why did these companies emerge separately from the major banks? Like, why in theory is this not just something that's done inside of Goldman Sachs or inside a Morgan. Very good point. And indeed, at some point, Goldman Sachs and Morgan Stanley were big physical traders. They were moving millions of barrels a day of crude and refined products. Goldman Sach's pre-IPO owned an oil refinery in Rotterdam. Morgan Stanley was a big trader of all kinds

of commodities, including metals, agricultural, etc., etc. But over time, this business gravitated to privately on independence because you have to go to difficult places on earth, places that usually regulators will not like banks to be there. And because over years, the good money on commodity trading has been made in operating on those kind of, what is the nice work, gray areas of the global economy? It feels like you have to have a somewhat mercenary attitude,

where it's like, this is the job. The word that Jack and I use on the World for Sale on our book was you have to be a bit of short short short walking. I think that that probably is a nice way to say buccaneer or mercenary. But look, the commodity traders made a lot of money over the last 30 or 40 years, helping Saddam Hussein to bypass UN sanctions, helping upper heads of Africa government to get oil, helping Fidel Castro of Cuba, barter sugar for oil. and keeping the communist revolution alive. And they never have a problem, whether it was a communist regime or a right-win regime. The same commodity traders that were helping Castro

were dealing with Pinochet in Chile to sell the copper. But you need to have the appetite to go to where no one goes. I mean, when I said earlier that these commodity traders are often in war zones, they are. They have executives. I have been in Libya during the civil war. and the hotel lobby where it was an interesting combination. You were in Benghazi, the front line was not far away,

were checkpoints on the city everywhere, and it was a hotel where it was kind of the hotel to be in town during the Libyan War. And the people who were living in that hotel were a combination of a few diplomats, cultural attaches of those diplomats, meaning the spies, a few war-writters.

world reporters and then the commodity traders, buying Libyan oil to put it into the global market. Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive, murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day. But not Vanguard. At Vanguard, institutional quality isn't a tagline. It's a commitment to your clients. We're talking top grade products across the board of over 80 bond funds, actively managed by a 200-person global squad of sector specialists, analysts, and traders. These folks live and breathe fixed income.

So if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com slash audio. That's vanguard.com slash audio, all investing in subject to risk vanguard marketing corporation distributor. They say abs are made in the kitchen. Cool, but who has time for three hours of meal prep and a fridge full of Tupperware? That's why I started using Factor. Factor delivers fresh, never frozen, ready-to-eat meals that are dietitian designed for balanced

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But thanks to Factor, I don't have to be in the kitchen. Right now, get 11 meals, free shipping, and free sides for life. Hurry, this offer won't last long. Go to FactorMeals.ca and use code pro. That's 11 meals, free shipping, and free sides for life, but only with the code pro at Factormeals.C.A. Factor. Canada's number one ready-to-eat meal delivery service. So setting aside, I guess, the issue of morality as many traders have done historically. You mentioned the fact that commodities traders just make tons of money over time. And I'm curious what the money-making opportunity is like right now. Because again, it kind of feels like a best of times, worst-of-time scenario. So the opportunity to make profit is there if you can secure the funding and navigate the volatility. But,

It seems like the industry is also starting to split a little bit. Like the big guys are taking even more market share. Some of the smaller players seem to be really squeezed by the financing pressures. What's going on there? You are right. The banking financing is gravitating towards the big players because the banks feel that they have enough equity to withstand the volatility and the smaller, medium-sized traders are really struggling to get support from the banks.

The opportunity right now is you can make it through, you can weather the volatility, you could make a ton of money in this market. I mean, think about Russian oil. The flagship of Russian crude is something that we call Urals. That is selling around $35 discount to brand, which is the main benchmark. So if you are a commodity trader, you could buy from Rosnev, oil at a $35 discount, put it on a boat, and ship it to. India where you could sell it at $5 discount. You could make 30% margin on a barrel of oil right now, which is a lot of money. I mean, this is an industry where making 50 cents on a barrel of oil is a big profit.

And all of a sudden you have $30 profitability options. And that's what they are doing. I mean, you see the same traders who are buying Russian oil at a discount of $35. They are selling it to India at a $5 discount. There's a, for anyone who's interested, or if you have a terminal, we have a Euro's Brent spread ticker, F-U-D-B-M-1. And you can see, like, you know, up until basically the beginning of February, this was a, you know, looked like Russian oil typically traded for about $1.50 cheaper than Brent. And currently, it's $31 cheaper. So basically, here's this huge opportunity.

All you need to do is find the boat. It's such a crazy chart. Right, that's the basic idea. If you can find a boat that can ship it to India for less than $30 a barrel. You need the boat, and you need also bank who's willing to finance that, or you need to have the equity to finance this operation on your own balance sheet. And then, I mean, but here's the question, will Joe commodities incorporated on the British Virgin Islands want to get involved in this?

Right. Would you want to be trading rask and oil? And many people will say, no, I don't want to do anything with Russia. But a lot of the commodity trade that say, well, we are not involved in politics. We are above politics. And we are here about making money. And it's legal to move the oil. So we are going to move it.

And they're obviously making a lot of money. Tracy, it actually reminds me a little bit of the same bankman-free Bitcoin trade from 2018. Like the huge gap in Bitcoin pricing in the U.S. in Japan and finding a way to like, But there's a reason why that gap exists. So, okay, speaking of gaps and crazy charts, there was something that you tweeted this morning, Javier, about the ultra-low sulfur diesel futures closing at like a crazy amount. And there have been a couple charts that just look like something weird is going on in the market. We're getting these odd technical squeezes higher.

What's going on there and how is that related to the financing situation? Well, the diesel market, I mean, I have been. been warning that we are talking a lot about the problem in the oil market, the crude market, but where real tithiness is what we call the middle of the barrel when it's refined, that's diesel and jet fuel. And we have very little of it because consumption is booming, because Russia produced a lot of diesel. What's happening there is that on commodity markets, when you are on the futures market, at the end of the day, some of those contracts are still physically deliverable. You take a long or short position and you may take or have to deliver the commodity to the exchange. Inventories of diesel

in the east coast of the United States are at the moment at the lowest seasonal level since we have data. That's 32 years. The pricing point for the futures market for diesel in the United States is here in New York Harbor. That is New York Harbor is where you price diesel for basically the whole of the Americas. And what happened here, really matters. It's so important that it was a big energy trader in the 90s at Morgan Stanley, who he was known as the king of New York Harbor because he controlled all the leases of all the oil tanks and he could, in some ways, I think that the war manipulate will be wrong, but he could sway the market on his favor very, very often. Because we have so little inventory,

everyone who is short in this market is trying to close the positions because come Friday, they need to deliver the diesel. There is not diesel around. The loans are very happy holding their positions. And what we have was a hell of a squeeze over the last 48 hours, where the premium for May to June contract balloon to an incredibly high level. I mean, it's something that, again, you know, this is a... a chart that we should see

a spread of no more than five, ten cents. Twenty-five cents will be something unprecedented. And yesterday we went beyond 70 cents, which was... The chart went vertical. And it was a clear sign that there was a short position in deep trouble knowing that in three days he has to deliver the barrels. It doesn't have any barrels and it needs to get out. And it will pay whatever is needed to get out of the position.

So, like, it's a pretty big societal disaster if certain commodities simply cannot be delivered. If planes can't get jet fuel, that's a really big economic problem. In fact, it briefly happened at the airport in Austin, Texas, that they ran out of fuel at that location. But other things, obviously food, obviously huge implications. You know, this stuff really matters. And so it's interesting, you know, talk to us a little bit about the role of regulators in the central banks? Because, you know, there was talked last month with the whole nickel blow up about, what, should the central banks be backstopping or bailing out some of the players in this space because it's so crucial. I mean, what is, do, does there need

to be more of a regulatory infrastructure such that if there is need for a bailout or emergency financing, the central banks are in a position to provide it? Well, using the example, that I gave you, you know, Joe commodities incorporated, well, you have no regulation. Right. No one is looking at you. It's pretty, like, you could do whatever you please. And, you know, this happened, just in mind that that trade that we're in mind,

you know, buying a barrel of Russian oil and delivering into Rotter than you will encounter not a single regulator other than on the financial side. And the financial side, when you are putting your head, you will have the CFTC looking at you what you are doing. But on the physical side, there is absolutely nothing. You still get the oil and put it on a ship. You put it on the ship and there is no regulation. And sometimes there is nothing even a single country because you may not even buy the oil from the terminal.

You may buy the oil on the high seas from, you know, sometimes two oil tankers get together. We call it ship-to-ship transfer. They get together on the high seas. They can move the oil from one tanker to the oil. Well, I didn't know that happened. And you are on the high seas. It's literally you are almost, the only rules there is the United Nations Convention of the Sea. It's kind of piracy level.

So you don't have any regulation. And it's quite interesting the things that you could get away or you could almost get away until very recently. For example, you were incorporated in Switzerland and you decide to bribe someone to get business, a businessman overseas. not only that was considered legal until very recently, but it was tax deductible. So the Swiss were rather accommodative to what the commodity traders needed to do. And on the book, we tell the story of some commodity traders telling us that they were traveling to London with half a million pounds on their briefcase to make payments to people. I mean, they call it commissions, but those are brown envelopes. There's also, there's a great story in your book about the Soviet Union.

basically owning the U.S. and the commodities traders in the 1970s by going from commodities house to commodities house buying up grain. And no one realized they were doing this with everyone. Because they don't talk to each other. They keep everything secret. And because there is no one that they need to report all of these transactions. There is not a registry. If you are trading on the financial market, you are buying oil futures or options, all of those trades are registry.

someone. There is a trade repository. The CFTC could look into it. The Fed can look into it. You know, if any indication of wrongdoing, someone can go and see exactly who bought what, at what price, with whom. On the physical market, you could buy oil, metals, agricultural commodities, and you do not have to disclose anything. There has been a terms. I mean, in 1979, the G7 agreed to create an international repository of oil. physical deals. And of course, what is now? 43 years later, we are here, and that has not happened because opposition from the industry. I can't even imagine getting to the point where people would agree to it now, much less enacted. Like, it just seems like...

When I recently was speaking to people on the regulatory wall and say, well, you could do, you could create a registry, and they were absolutely bemused that, I indicated, look, Look at the G7, 1979, Communicate, was the summit in Tokyo. It is there. He says, we agree. The G7 agrees to create an international database of trades. And they were like, well, that will not happen now. It's no way that all the countries will agree.

So just going back to the central bank point, though, so it seems like so far most of the major central banks have swatted away this idea of providing support. So the ECB kind of did it more definitively. The Fed has made noises that. suggest that it's not interested in backstopping commodities traders. Is the, A, why not? I guess moral hazard is the sort of big one there. But B, is part of the idea that they get support through banks that are backstopped by the Fed?

Yeah, I mean, I think that the central banks have looked into commodity trading recently, and they found two things that I think that they didn't like. One, and, you know, the Bank of England was rather candid about it. they put a position paper just indicating that they could not really even understand what was going on because of the opacity of the market. And to see a central bank recognizing publicly, we look at these, we found it to be very opaque, so we don't really know what's going on. It's rather concerning.

Both the ECB and the Fed say, well, the threshold for intervention of an unregulated market, as they call it, is very high. And the Fed, using Fed speak, effectively told the industry it will be a good idea if you raise equity and you shore up your own finance. I mean, let's not forget, a lot of these companies are probably on. They are very few that they are listed on the market. But they are also owned by extremely wealthy individuals. I mean, they are making billions of dollars every year. And the partners could put money back into the business.

The problem for the central banks is what if a big commodity trade, company was to fail and it goes under with billions of dollars on credit lines to a bunch of European banks and all of a sudden you realize that the likes of we were commenting earlier, you know, banks who have branches on the highest street in Europe have two, three, five, six billion dollars of exposure and you don't know what if is anyone else going to come down, the industry gets under massive stress. I think that we can, can get into a position in which central banks hands maybe use force into act and supporting the industry.

But it gets complicated because a difference of a lot of the banks, a lot of these commodity trading houses are not even incorporated in Europe. You are going to be bailing out companies that are in the British Virgin Islands, in Dubai, in Singapore. And companies also that, you could discuss whether what Lehman Brothers or Bernstein were doing, were good for society and so on. But these companies, a lot of the trouble that they're getting now is because they are trading Russian oil.

Right. Which goes... So, you see, mind in a situation in which a central bank effectively has to bail out a commodity trading house, and the central bank is either the Fed or the ECB, and you are bailing out a commodity trading house which is involved in shifting Russian oil, which is more or less against what... A company... A trading house in a tax haven.

and making it easier for Vladimir Putin to get revenue and now coming potentially, thinking the ECB or the Bank of England or the Fed, they feel like the tip to be able to be able to. Do you see what the hearing in Capitol Hill when they asked, you know, Chairman Powell and Secretary Jalen, why you bail out these guys? Yeah.

I mean, you know, you understand why the Fed and the ECB were terrified at that situation. But on the other hand, while both the ECB and the Fed have said no, I think that they're very aware that it could be a situation in which they may have to because the financial health of a number of European banks is at risk. But the political consequences of having to bail out these guys

are terrifying. Yeah, I hadn't thought about that at all. Something that you talk about is, and again, I guess I'm going back to the why of these companies, is that in the past, and maybe it's with oil, but I think other commodities as well, the supply chains were much more vertically integrated. And so whether from the drilling to the literal gas station

where someone would get their fuel, it might have been like all one company. And then there's sort of like as that fragmented, you talk a little bit about how the trading houses emerged out of essentially a restructuring of the industry itself. It happened mostly around the 70s, 60s and 70s. and, you know, oil was particularly the one that broke down. I mean, it was a time where everything was vertically integrated in the oil industry.

Exxon oil, exon oil fields will produce oil. They will put on Exxon-on-on pipelines into Exxon-on-on tankers, to Exxon refineries and to Exxon gas stations. And that broke down for a number of reasons, very importantly, nationalization of the oil resources in the Middle East and North Africa through the 70s. The commodity traders, when the Middle East countries nationalized their oil, all of the sudden, those countries who have never sold their own oil have plenty to sell and they needed someone

to help. And that came the oil traders who became the big intermediaries. And the industry has really broke down. There is not that vertical integration anymore. And the traders have benefited from that. Would you expect some form of vertical integration to return? Like, the obvious one, given the shipping shortage, shipping issues would be for commodities traders to just start buying or building a bunch of huge, very large crude carriers or

stuff like that. Would that kind of thing come back? I think that where you may have some vertical integration is companies have come to realize now that they need a particular supply that is critical for their business. and no one is investing, they may have to do it themselves. I mean, Tesla is kind of a good example of this. I mean, Alan Mons is talking about the shortages of lithium. So you could see at some point Tesla having to go into mining lithium

or co-investing with some traders into that because, you know, in effect, you have a market failure, so you may want to integrate. The one thing that I see, which is not vertical integration, but is the commodity traders have benefited a lot from the movement by everyone to just in time. They were the ones who were holding inventories for everyone else. And they made money from that.

I mean, a lot of companies, they didn't have to carry inventories. The inventories were on the hands of the traders. The traders were financing those inventories. So a lot of cheap financial officers of companies that need resources were very happy not to carry those financing costs. All of a sudden, you realize that just in time may not be a great idea. And if you are a company that needs a lot of alumni, Minion or a lot of copper, you may want to move from relying a bit less on the commodity traders

and controlling a lot more of those inventories, which is really bad right now because we have low inventories everywhere, supplies struggling with demand, and we are having it's a number of companies building their own inventories right now at the worst possible time, which is exacerbating the shortage. You know, this is a real diversion, but while you're here, I'm just going to ask you, did anyone actually get paid to take oil in spring 2020 when it went negative? Like, were there some people in a position where they, like, took oil and got paid to warehouse and made a fortune?

Yeah, there were. There were some commodity traders certainly buying oil in Cushing, and, you know, by buying, I mean getting paid to take the oil. There was not a lot of it. And, you know, the reason that we went negative was a lot of technicality around the contract and probably some people pushing the market at closing in the right direction. for their positions, but yes, there were commodity traders who that day, and not only that day, I mean, on the physical market in the US, for a few weeks before the WTI went negative, we have

domestic grades on kind of areas where are very difficult to move the oil out, where prices went negative, and some of the commodity traders were taking the oil. I mean, Mercury, a big oil trader, who takes oil in some areas of the U.S., which are lack lockdown with very difficult access to pipelines and so on was buying at negative price for about two weeks. They say abs are made in the kitchen. Cool, but who is time for three hours of meal prep and a fridge full of Tupperware? That's why I started using Factor.

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for two years. Fast internet? Long ad. worth it. Visit bell.ca for more details and to check availability. Bell, connection is everything. There's one part of the commodities ecosystem that we haven't really discussed yet, and it was the drama that I was referring to in the intro, and that's the exchanges. And the big drama was the London Metals exchange canceling a bunch of nickels trades after the price just went absolutely nuts. And this was really controversial at the time. But obviously a lot of what the commodities traders are doing are through futures contracts that go through an exchange. What sort of response have we seen from the exchanges

in terms of adapting to this new environment? Well, the response from the exchanges have been to increase margins massively to everyone, and particularly not just variation margins by initiation margins. It's very expensive right now to put a trade on energy commodities, oil, power, gas. It just have got very, very expensive. I think that the reaction from these changes have been, oh my gosh, we got very, very close to disaster with the LME.

I mean, the LME have not shut down the nickel market and then cancel the trades, which is an extremely controversial decision. And many people on the market will say illegal decision. And this is going to go into lawsuits, et cetera, et cetera. But the exchange has been quite open. Four or five brokers will have default that morning. was shut down at 8.15 in the morning and the trades were canceled at 8.15 in the morning, margin calls were due at 9. So we can say that four or five big brokers at the LME were 45 minutes from going belly up. If the brokers go, what happened to, because then the broker's default

to the exchange and the clearinghouse. What will have happened to the clearinghouse? The exchange said that the clearinghouse will have survived, but we don't know the reality. and what would have happened to some of the banks, which are behind the brokers. I mean, the financial consequences could have been significant billions of dollars of losses. And, you know, a lot of the risks today, we have moved the risk out of OTC markets

into clearing houses. And, you know, we don't know, and this was a test. I mean, having to cancel the trade is a massive decision. I mean, you know, my war is my bond. I have a trade. I have a contract, and that's done. And those contracts were evaporated in minutes. So the exchange's reaction so far is to increase margins and trying to make sure that the buffer on the clearinghouse is there for a potential default.

But obviously, that's draining a lot of liquidity from the exchange. We have seen liquidity in the oil market at a six, seven-year low that's not coming back. At times, the oil market, I think that I said that the bid has spread on WTI, which usually is no more than one cent. there were times that it was seven, eight cents wide, which I said, well, that's wide enough to put an oil tanker through. I mean, like, you could make eight cents of a dollar just basically arbitration bid as spread on WTI, which is insane. That's kind of almost free money. Crazy. You know, we talk about like, oh, these commodity traders are making a ton of money, but they weren't always. I mean, you know, prior to 2020, prior to COVID, commodities was not

a booming business. And one of the themes that comes up, up a lot on odd lots is, you know, this idea of like underinvestment, under investment in physical resource, et cetera. But I'm curious also about like the sort of, I guess, the ESG aspect. Because my impression is, and I think some people want to dismiss that. Other people say it's everything. But my impression is a lot of people just either different kinds of financial companies just sort of like cut all of their units related to restrictive industries, related to mining and so forth, they're like, we're just going to get out of this business. It does feel like the sort of negative attitude towards dirty industries

really caused a lot of these sort of financing to disappear. The Russian invasion of Ukraine has been really the final straw on the market that has tightened things a lot, but the market was already tightening a lot on the run-up. And one reason is that we have under investment in fossil fuels, in mining. It just generally has been seen as a dirty industry. ESG has kick in. We're not having probably enough investment. I mean, here we are at unprecedented prices for coal.

I mean, a good price. If you have told a coal miner a couple of years ago that $250 a tonne, where they will take it. I mean, they will have signed a contract right now. Thank you very much. That's a great price. And the market is now at 400. And no one is building a mine.

No one is opening a coal mine. of coal finance. Everyone is out of cold finance. You could not get a bank to finance a coal mine. And, you know, some of the coal companies I speak to the CEOs and say, why, you are not now announcing a big expansion and so on. Because it said, if I announce that we are expanding production capacity, my share price goes down 10%.

Because that's the last thing that, you know, we have targets, that we have to reduce. And, you know, the sad thing right now of the energy transition is that we have been talking about cutting emissions and reducing CO2 and so on. And 2022, we are going to see record demand for oil, record demand for natural gas, and record demand for thermal coal. And that's despite the fact that we have been trying to reduce reliance on thermal coal for the last, I mean, some people will say 150 years, but seriously for the last 20 years. I have a related but slightly weird question. But speaking of underinvestment, you know, central banks around the world gearing up for rate hikes if they haven't done so already. And the whole intent there is to try to bring down

inflation, which presumably with lower commodities prices. But I'm curious, how do commodities traders feel about rate hikes at the moment? Because the other argument you could make is that you're increasing the cost of capital, the cost of funding at precisely the wrong time for that particular industry? I mean, commodity traders, they feel that demand is outstripping supply and that the only thing that could bring down the market is just a good old-fashioned recession. So can you reduce commodity prices via interest rates hikes? Yes, but at the cost of killing the economy. But if you're going to achieve the soft landing, I don't think that you are, I mean, the demand is going to be still there. I don't see how that's just going to reduce inflation.

I mean, nothing that the Fed can do other than killing the economy can bring more oil or more coal or more wheat. I mean, you know, we have a problem with wheat supplies right now because we have lost the number one and number three supplier to the wall. And the ECB, the Bank of England or the Fed cannot do anything about that. I mean, you know, higher interest rates are not going to produce more wheat and they're not going to produce more oil. But, you know, interestingly, I mean, interesting, this is the statement of the obvious. Right now, the global economy faces much higher energy costs, much higher food costs, and higher cost of money. So, you know, I have a hard time wrapping my head around how big of a deal it is to say, okay, some European countries are going to buy Russian gas in rubles. Or maybe China is going to enter into some contract of Saudi Arabia to use UN.

And some people, when these headlines hit, oh, there's a huge deal. It's the end of the dollar. And I'm always not sure how to think about it. Just what's your take and like, how significant is pricing commodity sales and non-dollar currencies? Is it a big deal or is it sort of just accounting? Depends on what we are talking about. We are talking about pricing the commodity in a non-dollar currency. Then I think it's a big deal.

But a lot of what we are talking about is about invoicing. Right. The commodities is still priced in dollar. But you switch. You are pricing dollars, but when you transfer the money, you wire the money in a different currency, which is a very different thing from, you know, non-pricing in dollars. Look, I do think that it does have an impact. Obviously, there are a number of countries that they try to reduce their reliance on the dollar. But it was quite interesting.

I was recently speaking to a senior executive of a Middle East company about what would you want to get paying yuan? and he's not a friend of the United States, this particular gentleman, but he said, and then what do we do with the yuan? We get paid with the yuan. It's not properly convertible. We can pay for Chinese goods,

but do we have enough demand for Chinese stuff? And they may not like the dollar. They may not like policies with the United States, but they know that the moment that they have the dollars, they can convert that to anything that they want, they can move it around, etc., etc. So you've been covering commodities for a very long time, and obviously your book deals with the long-term history of commodities trading. What about the past month or so has surprised you? What's been the most striking to you?

A couple of things. I have been struck by how little regulators in this day know about the industry. The fact that a lot of them seem to be completely in the dark of what's going on and who are the big. players and how things work, considering that we have had several White Cup calls, I would have thought that regulators will have really getting up to a speed onto that. And that is really concerning because I am not a big believer that you need super extra heavy regulation on commodities, but really concerns me when regulators and policymakers basically have no idea what's going on. That remains a surprise. The other one, on the other hand, has been self-sensioning. How, you know, public pressure has led to so many players to say, even if this is legal, we are not going to touch it.

I don't know. This is an era of social media where public pressure goes quicker to companies, but in the past, I will have expected a lot more companies to continue dealing on Raskan oil with no problem. And we have seen a number of companies just, you know, taking a step back. And the companies that try to use the old tricks, like do blending and things like that, getting name and shame and very, very quickly say, oh, yeah, our mistake, we're not going to do that. Yeah, you've had some great columns about blending,

and they call it Latvian oil. That's a Latvian blend. It's like a coffee. It's like a coffee. It's like coffee or cocktails. You kind of, you know, you mix. So it's when Russian oil is not really Russian oil, I mean, for some companies,

they will say that as long as 51% of the oil is from somewhere else, the other 49% could be Russian. And then they invent all these names, which are kind of, you know, cocktail names, Latvian blend, to many-stani blend, to avoid calling it 49% Russian. I just have one more question, and I guess it's like a culture thing again, but, you know, in this world of commodities being so important. You know, and I think of traditional traders,

maybe they're like physicists these days or electrical engineers or mathematicians or something. Who becomes commodity traders? Huh. I imagine like language. skills might be useful. If we're talking about all these international... I think that language skills, you have to have a sense of adventure and, you know, be willing to live in the middle of nowhere, travel 250 days a year, take quite a lot of personal risk.

There is a commodity trading house called Olam, which is based in Singapore, and the CEO is a gentleman called Sunny Bergeese. Mr. Bergeese started in Nigeria. So he still sends all the John traders upcountry in the middle of nowhere for a couple of years. So they learned the business. Wow. The kind of the hard way. I mean, you need to be prepared to go to live in somewhere quite distant. This is not, if all what you want to do is be sitting in Mayfair in London or, you know, Wall Street here in New York, that's not the business for you. You have to be, you have to be willing to go to Kinshasa in Democratic Republic of Congo and know everyone there, know the

president, know your ways to get the copper and cobal. out of the country. I think a lot of people would like that. I bet just you describing that. It's like, I've been a bunch of people hear that. It's like, I want that life. Even in journalism, when I started out in financial journalism, I wanted to report on commodities and it didn't happen for me. So I had to make it happen through all thoughts at various times. Well, I mean, you know, you are a commodity reporter. You end visiting a lot of countries that they are not the traditional, you know, holiday destination. It's kind of my dad used to say, so you look at the delays of countries and the foreign office recommend not to travel.

And you basically... What's your favorite place that you visited that hardly anyone else has been? Look, I have had a great time every time I have been in Iraq. It's one of those... My favorite places. Baghdad is a great place.

I have favorite restaurants in Baghdad and things like that. I mean, you get to travel a lot to the Middle East. And Iraq and Iran are kind of favorite places. But also, you need to get used to, from time to time to get deported for a few countries. Right. Well, Javier, that was fantastic.

I think I said at the beginning, you're one of the most requested guests, and I can see why. So appreciate you so much for coming on online. Thank you for having me. That was great. Thanks so much, Javier. I'm glad we can make it happen.

So, Joe, obviously, that was a really enjoyable conversation. One of the things that struck me is just how untransparent this market seems to be. And, you know, Havier's point about, how we still don't have a trade repository for physical commodities is just like in in this day and age on the one hand everything in the world seems to be tracked except actual physical vital goods which is insane but on the other hand I cannot see anyone in the current environment actually agreeing to do it yeah when you actually that's what I thought too and when you actually think about what it would take it's like how would you even do that like how would you regulate

and create a central repository for something in which you can literally swap the oil from one boat to another boat. And you could mix the oil. So he was talking about the Latvian blend of, okay, you have a barrel of oil that's 49.99% Russian and 50.01 something else. Like the, just the complexity of that, like, how would you even like start to conceptualize tracking every trade when there's so many ways to just do a unilateral one-to-one handoff of a good, you could see why it's so tough. Absolutely. And then the other thing that was striking to me, I don't know, a lot of it felt like confirmation of this idea that going forward, getting commodities is just going to cost more money. Like it's going to be more difficult to get financing. There's going to be

extra volatility. It seems like, which means you have to pay additional variation margin. The exchanges have already upped the initial margin. So the whole thing, and I haven't even mentioned shipping, shipping costs through the roof. It just, and insurance. It just feels like everything is coming together to make it more expensive. Expensive and complicated. And so this idea of like localized shortages where even if you ostensibly have the money to pay for the price of a commodity that appears on the screen, can you actually get it delivered to an appropriate to an approach? predictable manner. It feels like that's going to get tougher or going to stay tough. Right. It's a

sort of disconnect between the financial and the physical, which we've been talking about. And that's also why what was happening with the New York diesel contract that Javier was describing is so interesting as well, because that's the kind of localized stress that could happen. Or, you know, the other, and he made this point, which is that everybody remembers when WTI oil went down to negative 40. But there were other regional benchmarks. We don't talk about them, but if you look on the terminal, there's like dozens of North American oil prices, depending on what pipelines they have access to and the cost to get them out. And some of those were already negative. And it's like, well, who has some empty space just at the right moment to charge someone for getting their oil off a boat or out of a pipeline?

Just incredibly complicated during fallacy times. Yeah. Like an industry that was already insanely granular is just getting even. more granular and specific, it feels like. I thought that was interesting, too. It's like the oil traders, like, what am I going to do with Chinese yuan? Like, okay, even if you don't, even if you don't really love the idea of having your entire business being denominated in dollars, other currencies may not be that appealing. It's nice to have a fungible global reserve currency.

That's for sure. There's some benefits. All right. Shall we leave it there? Let's leave it there. Okay. This has been another episode of the Oddlots podcast. I'm Tracy Alloway.

You can follow me on Twitter at Tracy Alloway. And I'm Joe Wisenthal. You can follow me on Twitter at The Stallwork. Follow our guest, Javier Blas. He's at Javier Blas. And also check out the book he co-author with Jack Farchy, The World for Sale. Follow our producer, Carmen Rodriguez, at Carmen Arman. Follow the Bloomberg head of podcast, Francesca Levy at Francesca Today.

And check out all of our podcasts in Bloomberg under the handle at Podcasts. Thanks for listening.