Issue 146, November 2015
Glencore's costly expansion from trading commodities into owning mines resembles a failed strategy by bankrupt airline PanAm. That at least is the view of the former chief executive to one of Britain's biggest companies, who was approached to become Glencore's chairman.
Talking anonymously, because Glencore's board appointment process was confidential, he says airlines expanded into owning hotels in the 1970s and 80s, attracted by overlaps and the same customer base. But the strategy always failed, because they became tied to destinations where they had sunk capital, losing flexibility.
Glencore's trading business similarly flips commodities across ever-changing trade routes. It has shipped large volumes of gas from the US to Asia in recent years and a harsh winter in Europe will see it use ice-breakers in the Baltic to export gas from Russia.
But as its shares have nosedived this year, chief executive Ivan Glasenberg has been criticised for bulking-up on mines and branching too heavily into fixed assets, from oil fields to grain depots, swelling the group's capital commitments ahead of a deepening downturn.
Now the group may be forced to reassess the value of its mining business, following shutdowns in copper and zinc. It has already announced write-downs of at least $9bn since buying mining giant Xstrata for $65bn in 2012.
But the best brains at Glencore reject any comparison to the airline industry. Glencore's strategy is “totally different”, one director says. The overlap between mining and trading is the “same as airlines running their own booking business,” he says, “as they do. We own our assets and sell the product in the best manner available.”
PanAm built one of the world's largest hotel chains at its height in the 1970s, but hit financial difficulty and began selling non-core assets, finally succumbing to bankruptcy. Air France, Japan Airlines and British Airways have all also experimented in the hotel business, without success.
The analogy is “probably a bit extreme”, says Investec analyst Marc Elliott, who triggered a collapse in Glencore's share price in September with a bearish note. “They moved in the asset-heavy direction, which all traders were doing, but Glencore is now faced with the reality that its industrial footprint is so vast, it can't move back.”
Glencore's shares have bounced since September, up 35 per cent, but confidence remains vulnerable to a massive surprise impairment, seasonal copper price weakness, credit-rating downgrades or a sell-note by Goldman Sachs.
Academics who have studied trading firms say the analogy to airlines is fair. “The perception is that Glencore violated the fundamental law of commodity trading firms by going very long,” says Professor Scott Irwin, a grain trading expert at the University of Illinois. “Their timing was terrible and it may or may not drive them under.”
Glencore insiders argue that its hybrid strategy, bridging trading and production, has been pursued for decades by oil super majors, including BP and Royal Dutch Shell.
BP is seen by the market as an asset-owner, but is also sitting on one of the world's largest and lowest profile trading businesses, booking more than 2,000 trades per day. It has not broken-out its trading profits since 2005, when it reported earnings of $3bn, but actively trades the futures market and has pushed against new regulations aimed at introducing position limits and higher levels of public disclosure for trading firms.
BP's finance director, Glencore's head of oil Alex Beard and Swedish oil trading boss Torbjorn Tornqvist all began their careers in BP's trading division, whilst BP's former group chief executive Tony Hayward ultimately landed the role of Glencore's chairman.
“The distinction is that the balance sheets are very different,” says Craig Pirrong, a finance professor at the University of Houston, who has worked with Glencore's trading rival Trafigura. “Maybe if Glencore had implemented the strategy with as little leverage as Shell and BP, it would have worked out differently.”
Glencore's shares closed on Friday at 92p; a market update is due in early December.
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