Financing Physical Trading

Financing has become a much larger part of commodity-trading P&L.

For much of the period following the 2008 financial crisis, the largest commodity companies could borrow at extremely low rates. Financing inventory was still a cost, but it was rarely the factor that determined whether a trade worked.

That has changed.

Even if commodity prices had remained unchanged, the move from near-zero benchmark rates to borrowing costs of 6%, 8%, or more would have materially increased the cost of buying, holding, and transporting physical commodities.

But commodity prices have not remained unchanged, they have risen considerably. This means traders are now paying a higher interest rate on a much larger underlying value.

Take a copper shipment purchased FOB Chile and sold CIF China.

At a copper price of $13,500/mt and a 45-day voyage, every 1% of annual financing costs equates to approximately $17/mt.

A trader paying 8% would incur around $135/mt in financing during the voyage. A large trading house able to borrow at 6% would pay approximately $101/mt.

That two percentage-point funding advantage is worth ~$34/mt. On a 10,000mt shipment that's $340,000 and over an entire trading book it can amount to tens of millions of dollars.

This creates an uneven playing field. The larger trading house can offer the producer $34/mt more and still earn the same margin as its smaller competitor. Alternatively it can match the smaller trader's offer and keep the difference as additional profit.

The smaller company must accept a lower margin, find additional value elsewhere in the transaction, or lose the business.

This shift is also changing the role of the finance department within commodity companies. Historically finance functions were often viewed primarily as back-office support. They arranged facilities, processed interest, and monitored liquidity.

But increasingly their work is middle-office, and even commercial in nature. The structure, timing, and cost of funding can now determine whether a trade is competitive before it's ever executed.

Strong finance teams materially influence the profitability of a trade by negotiating better facilities, matching funding to trade duration, improving the cash-conversion cycle, and allocating scarce liquidity to the right opportunities.

Size, scale, and access to capital has always been rewarded in commodity trading. But when both interest rates and commodity prices are high, the value of that funding advantage becomes considerably greater.