Glencore made a speculative bet on rising wheat and corn prices in the early stages of last summer’s Russian drought, the world’s largest commodity trader has revealed ahead of its initial public offering that will value the company at $60 billion.
As it bet on rising prices, senior traders at the Swiss-based company publicly urged Russia to impose a grain export ban. Moscow acted a few days later, triggering a grain rally. Glencore is the largest trader in Russian wheat, followed by US-based rivals Cargill and Bunge.
The issue is sensitive because politicians such as Nicolas Sarkozy, French president have often blamed speculators for rising food prices. The G20 group of leading economies will hold a special meeting in June to discuss grain markets.
Glencore revealed the proprietary trades to UBS, one of the banks underwriting its flotation, in a rare disclosure for a company that guards its market insights closely.
“[Glencore’s] agricultural team received very timely reports from Russia farm assets that growing conditions were deteriorating aggressively in the spring and summer of 2010, as the Russian drought set in,” UBS said in a pre-IPO report circulated to potential investors and seen by the Financial Times. “This put it in a position to make proprietary trades going long wheat and corn.”
On August 3, Yury Ognev, head of Glencore’s Russian grain unit, encouraged Moscow to ban wheat exports, saying: “From our point of view the government has all the reasons to stop all exports.” His deputy made similar comments. At the time Glencore distanced itself from the comments, saying they represented Mr Ognev’s personal views. Russia imposed the ban on August 5, sending the price of the cereal more than 15 percent higher in two days.
Glencore said on Sunday its overall positions in grains had mixed “outcomes” in 2010. The export ban trapped Russian wheat the trading house had bought in advance to supply a Middle Eastern country. “So we had to buy more expensive wheat from elsewhere to meet that obligation,” it said. “The export ban did not particularly help our business.”
Glencore agreed to supply wheat to its customer, believed to be Egypt, with a contract that did not stipulate the source of the wheat, something known in the industry as “optional origin” agreement. The flexible contract prevented the company from declaring force majeure, in effect a common legal clause that allows traders to walk away from supply contracts for causes beyond their control, such as an export ban.
Earnings before interest and tax at Glencore’s agricultural division more than doubled to $659 m last year, according to figures provided to analysts. Other top trading houses, including Cargill, benefited from the supply disruption in Russian wheat, but some, such as Archer Daniels Midland, suffered.
Glencore has stressed it rarely makes proprietary trades on the direction of commodity prices. It said profits from such activities account for a “substantial minority” of the profitability of its trading business. However, the company has not provided details of the split of earnings between its day-to-day arbitrage trading activities and its more rare speculative, or proprietary, trading positions, analysts said.
Liberum Capital, which is part of Glencore’s IPO banking syndicate, estimated that proprietary positions probably account for single-digit percentage of the company’s overall profits in trading. But Olivia Ker, lead analyst on the UBS report, wrote that without further disclosure, “valuing the profit stream from Glencore’s proprietary trading will be an act of faith by investors”.
Analysts at the nine banks involved in the IPO have put an average valuation of $62 billion on Glencore, with a third of that coming from the trading business. The flotation, expected to raise up to $12 billion in late May, would be the largest in London and the third-largest in Europe.
Glencore has said it expected to become only the third company – and the first in 25 years – to enter the bluechip FTSE 100 index on its first day of trading.