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Commodity Trading: The Secret Behind Big Oil’s Windfall Profits

By on August 4, 2022 0

Dozens of giant commodity and energy traders have seen their profits soar during the pandemic thanks to their ability to leverage their storage facilities, global network of terminals and shipping fleets to take advantage of market disruptions. supply, soaring energy prices and growing demand.

Vitol Groupthe largest commodity trader in the world, generated record net income of 4.2 billion dollars last year, with its rival Mercury raise $1.25 billion. Vitol has announced a major US$3 billion share buyback to reward the approximately 450 senior executives who own the company. Glencore Plc also broke records, as did Trafigurathe commercial branch of. Small trading desks that lack the means and deep infrastructure networks of giants have unfortunately been unable to take advantage of one of the most volatile and profitable times in the global energy industry. .

But the trading of energy commodities is by no means the exclusive prerogative of independent trading desks. Dozens of major oil companies have set up secretive and sprawling business divisions that frequently add billions of dollars to their bottom line.

Source: Financial Times

The commercial genius of BP

While several American oil companies have dabbled in the oil business, it is the European oil and gas supermajors that seem to have perfected the art and science of taking advantage of volatile oil markets to reap big profits.

Namely, last year, Exxon Mobil (NYSE: XOM) has abandoned efforts to build an energy trading business to compete with those of European oil majors after a period of low oil prices forced the company to drastically cut funding for the unit in through deeper spending cuts. The cuts have left Exxon traders without sufficient capital to take full advantage of oil market volatility. The coronavirus pandemic sent oil and gas prices plummeting, before a strong rebound created a huge profit opportunity for business operations willing to take the risk. Unfortunately, cash flow problems and pressure from investors have forced Exxon to systematically avoid risk by withdrawing most of the capital needed for speculative transactions, limiting its traders to working only with long-time Exxon customers and submitting the most transactions subject to high-level management review.

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BP S.A.. (NYSE: BP), on the other hand, managed to build one of the most successful energy trading businesses of a major oil and gas company.

In his last call on earnings, the European supermajor said its underlying profit at replacement cost — a measure similar to the net income figure commonly used by U.S. oil companies — soared to $8.45 billion in the second quarter from 6, $25 billion in the first quarter, reflecting strong refining margins, higher liquids realizations and exceptional oil trading performance. This figure was well above Wall Street’s expectations of $6.79 billion.

“The main driver of the strong upside was another exceptional quarter in petroleum trading,” RBC Capital Markets said in a note.

But these record profits were by no means a fluke. BP’s trading desk has been astute in taking advantage of highly volatile energy markets in the past, with former CEO Bob Dudley and his army of 3,000 traders displaying an astonishing ability to predict the trajectory of oil prices. For example, Dudley told the media that “prices will stay lower for longer”, after oil prices plunged to their lowest level in more than a decade in January 2016. This time, however, his well-known mantra came with a kick: “But not forever.”

Few have grasped the special significance of Dudley’s comment. Essentially, BP traders had turned bullish after months of falling oil prices. BP’s trading arm argued that the price had fallen so much that it could only rise, and Dudley agreed. And, in total secrecy, the company was willing to bet its traders were right again and put its money where it said. Indeed, Dudley authorized a bold trade that saw BP place a big bet on a rebound in oil prices. BP was already heavily exposed to (low) oil prices, but opted to double down in an effort to increase exposure by buying futures like a hedge fund would. This bet, worth hundreds of millions of dollars, remained a closely guarded secret for years and was not disclosed by Bloomberg until 2021. BP quietly bought Brent futures contracts in London on a “managerial position” – a trade so large that it had to be overseen by the company’s most senior executives.

And, successful bet. By early February, oil prices had risen by a third, trading above $35 a barrel. At the end of May, oil prices reached $50 a barrel. A former BP executive with direct knowledge of the trade told Bloomberg it was “making a lot of money”, valuing the payout at between $150 million and $200 million. Publicly, however, BP has said next to nothing.

BP’s competitors SA shell (NYSE: SHEL) and TotalEnergies (NYSE: TTE) are also among the largest commodity traders in the world. Shell is in fact the largest oil trader in the world, ahead of independent houses such as Vitol Group and Trafigura.

The massive trading floors that sometimes rival the biggest banks on Wall Street are becoming increasingly important to oil companies amid fears that global demand for oil will soon plummet due to the global energy transition as well as worries regarding climate change. However, much of the oil majors’ business exploits go unreported, as did BP’s business in 2016. But few shareholders would object: BP typically makes between $2 billion and $3 billion a year from its trading desk, roughly equivalent to what the company’s upstream activities generate in a normal year; Shell makes up to $4 billion in pre-tax profits from oil and gas trading, while French major Total is not far behind.

By Alex Kimani for Oilprice.com

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