Many of the world’s major oil and gas and mining companies have already established international trading structures to gain competitive advantage, and the trend toward centralized trading is expected to continue. National oil companies are also centralizing their trading activities in key international trading centers. As the majors consolidate their supply chains, downstream service companies are under pressure but have opportunities to diversify their activities.
- Centralization and cross-pollination with members of the banking sector is allowing pure energy producers and mining companies to take part in a more diverse range of financial activities.
- The greatest uncertainty of international trading companies is the specter of more stringent tax and trading regulation.
- Commodity prices will dictate the future of international trading companies. As long as commodity prices remain high, the trend toward centralization in favorable trading locations will continue.
As commodities trading continues to globalize, operations that focus on only one geographic region or that rely on point-to-point supply chains will have greater difficulty meeting customer demands. The higher margins that international trading companies can generate could force some smaller players out of the market.
Some national oil companies of smaller, resource-rich countries (e.g., Finland, Azerbaijan) that are seeking to expand are setting up international trading companies as entry points to international commodities markets. Oil producers from Gulf Cooperation Council states and former Soviet Union members, which traditionally sold commodities through long-term contracts, are centralizing their sales and marketing arms to increase margins.
Meanwhile, centralization is allowing pure energy producers and mining companies to evolve from supply chain trading toward a more diverse range of financial activities, from hedging and proprietary trading to treasury functions. In Switzerland, banks and energy companies are developing highly sophisticated hedging products to protect their market positions, encouraging more divergence of banks into the commodity markets. Cross-pollination is encouraging a mutually beneficial blending of the two industries as financial executives travel between the two industries.
As the majors move into more sophisticated trading activities and integrate downstream processes into their supply chains, downstream service companies, such as smelters and refineries, are feeling the squeeze. But as the large majors shift their focus upstream, there are opportunities for downstream companies to move in. For example, some companies in the smelting business are strengthening their position by buying mines and engaging in primary production. Although more companies are expected to establish new centralized trading operations, further centralization among existing structures may not be practical. Beyond a certain point, centralization can cause a loss of geographic advantage in terms of time zones and proximity to commodities markets.
As noted, a multiple trading company structure that allows 24-hour trading across time zones is emerging as a common practice among the largest commodities companies. The greatest uncertainty for international trading structures is the specter of more stringent regulation. For example, the US Dodd-Frank Act represents a sea change for the way commodities are tracked, for the legal and capital structure of market participants, and potentially for the types of activities that traditional players are willing to continue doing in the future. At the same time, the world’s tax authorities could target international trading activities by imposing stronger legislative action to curb the use of these structures and gain a greater allocation of taxable profits, for example, through more prescriptive transfer pricing rules.
Additional risks arise for global commodity traders from the need to comply with economic sanctions. Economic sanctions are published at the international and national levels due to foreign policy and national security concerns. Targeted trade restrictions may be directed against nuclear proliferation, the oil and gas sector, and the financial sector. They may target certain persons and also specific countries or their governments (e.g., Iran, Sudan, North Korea). The measures prevent businesses from facilitating trade with these countries; violation of economic sanctions is a serious crime. A system of effective internal controls can help ensure successful trade compliance. Setting up a global trade management program that includes an economic sanctions chapter is essential for global commodity trading. In the final analysis, commodity prices will dictate the future of international trading companies.
As long as commodity prices remain high, the trend toward centralization in favorable trading locations will continue. But if the world’s commodity prices experience a sustained decline, this business model may falter as companies with losses decide to keep more of their trading activities in higher tax locations.
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