Glencore's Business Model
Glencore's Huge Scope
Glencore has an immense list of assets and makes money in wide range on enterprises which link together to create a commodities powerhouse.
- Oil Tankers
- Brazilian Grain terminal (with Archer Daniels Midland Company)
- Enough coal to make it the worlds largest coal miner
- Railroad cars
- 300,000 hectares of farmland
- Investments in Rustel, Century Aluminum, Minara Resources and many other listed companies
- Significant oil exploration and production assets
- A substantial recycling operation. For example the Horne Smelter has a capacity of 840,000 tonnes of copper.
- Owns ore refineries and smelters
- Over 90 offices in over 50 countries
- Over 180,000 employees
Introduction to Glencore
The Huffington Post perfectly described Glencore as "the biggest company you've never heard of". On one hand it seems incredible that a company as insanely massive as Glencore could be so obscure but given the complexity of their business it's no wonder that it gets missed.
Fundamentally Glencore is a commodities trading firm - everything Glencore does can be traced back to this. The company also has a massive mining arm which although profitable on its own gives it significant advantages in the marketing and trading of commodities.
The companies operations initially look like a collection of different business. They've got trading desks, derivative businesses, they operate mines, the store grain and they have a huge army of logistics which transport commodities all over the globe. The company even owns 300,000 hectares of farmland in Australia. However, their is a common strand that runs through the whole operation and is key to Glencore's profitability and that is the marketing business. You see all this owning farmland, transporting commodities and owning mines gives Glencore immense insights into the workings of the commodity market. This data informs their trading and has been hugely profitable. With only the possible exception of Nobel Corp no other company has really managed to replicate this extraordinary business model. Though Glencore has faced a great deal of controversy having been accused of tax evasion, safety failures and being a cartel.
Glencore is now a stock market traded company so if you believe that they have a good business and the market is giving you a good price you could invest. They are listed on the London Stock Exchange under GLEN, the Johannesburg stock exchange under GLN, the Hong Kong Stock exchange as 0805 and trade in the United States though the OTC market under GLCNF. However, before you invest insure you fully understand Glencore - this is much easier said than done.
If you don't understand the concept of futures you will never understand Glencore and how it makes money. Futures are absolutely essential to the operation of commodities markets.
The basic idea is that you agree a price now for a commodity in the future. For example you agree to buy one thousand tonnes of grain from a farmer at $X per tonne next year. This is a futures contract - the farmer agrees to deliver that quantity in the future and you agree to pay him that price regardless of whether prices go up or down.
However, most futures contracts are actually settled in cash so the product does not change hands. The two parties simply work out who won and who lost based on what prices have done and they swap cash - the loser pays the winner.
The bread and butter of the Glencore empire is commodity trading. The scale of Glencore's operations in this area are insane - the company controls around 10% of the global grain market, around 3% of all the oil traded in the world passes through Glencore as does around 1/3 of the worlds coal and over half of all zinc and copper traded globally is facilitated by Glencore.
Put simply, the way you make money trading commodities is that you sell them for more than you pay for them. In practice it's more complicated and the trading systems are far more sophisticated. But ultimately this is the way that Glencore makes money. The trick is that Glencore is constantly profitable and has informational advantages.
For example imagine that you buy oil at $100. There are various ways you could make money. You could simply wait until the price goes up and then sell it at say $120 and make a lot of money. This is what's called a directional bet. Glencore does this but its not a major part of the business.
The key to the way Glencore makes money is that it does not matter very much were commodity prices are or where they go. Glencore makes money whether commodities go up, go down or go nowhere. Though they would prefer commodity prices to be high as they have a finite capacity so increases in price per unit boost profitability. Naturally the companies mining assets make more money at high prices too.
So how is it possible to make money regardless of what happens with commodity prices? The answer is planning and exploiting inefficiencies (i.e. mispricing in or between markets).
The planning aspect is simple. What you do is enter into two sets of contracts. Let's take coal for an example. What Glencore could do is enter into a contract to buy coal from a mine at a price of say $50 per tonne. Then Glencore could enter into a contract with a power-plant to supply them coal at $55 per tonne. Hence Glencore will make a profit of $5 for ever tonne it sells. If coal crashes spectacularly to $10 Glencore will still make its $5 regardless as both contracts are in place. Its also important to note that Glencore has the capacity in house to store and transport this coal. The power-plant is able to use Glencore to gain a steady supply of the coal it needs at a fixed price so they are happy. The coal miner is also happy as they get a good price for their coal and can budget based on this price which gives the company confidence that they will be able to operate profitably. The deal with the coal miner is what's known as an off-take agreement which is a key part of Glencore's business. The example here is simplified but it gives you the basic idea.
On the arbitrage side one of the key parts of Glencore's business is geographical arbitrage. Interestingly, the price for a commodity is not the same everywhere in the world. Hence if you pick it up in location X and sell it in location Y you can make the difference between the two prices less the cost of getting it from X to Y. This is part of the reason why Glencore owns, charters or leases so many tankers, rail cars and bulk cargo ships. It moves commodities from cheap areas to more expensive areas highly efficiently as it has the infrastructure, knowledge and on the ground relationships and staff do get it done.
Similarly Glencore also takes advantage of pricing anomalies in time. A commodity fluctuates in value quite wildly, at some times it is high and at other times its low. To manage this volatility producers enter into future contracts (see explanation in the box above). Hence there are times when the commodity can be bought at the market price (in what's called the spot market) and then delivered to fulfil the futures contract. For example you have a contract to supply X tonnes of coal at $50 next year. If coal is $40 now then you can buy it now and use it to fulfil your obligations under the contract and make $10 less the cost of storage. As we know Glencore has substantial storage capacity which allows it to take advantage of these discrepancies in pricing between now and a future date. Furthermore, they can also use their own production to satisfy the contracts.
Glencore is a Tale of Interlocking Parts
Glencore The Marketer, Miner and Logistics Company
Glencore also owns numerous mines or holds stakes in various mining companies (e.g. formerly held a stake in Lonmin). It is easy to understand how a mine makes money - you pull stuff out of the ground and sell it for more than it cost you to get it out. However, at Glencore the way the mining operation makes money for the group is more complex. Glencore's mining business is very useful to their marketing arm.
You see, the ownership of mining assets gives Glencore an advantage in the marketing and trading of those commodities. They can supply their customers directly from their resources and use their own infrastructure to transport, process and store their production which gives them cost advantages. An key element of Glencore's profitability comes from economies of scale.
Additionally owning the mines gives Glencore's army of traders huge insights into the market from which they can base their trading decisions on. The in house data that Glencore has is massively valuable.
Furthermore, Glencore also allows others to make use of its assets. It earns income from charging fees for smelting, ore processing, storage, commodities handling and logistics.
The Basic Process
|Activity||How Glencore Makes Money|
Glencore uses its in house knowledge to make bets on whether a commodities price is going to go up and down. If it is right it makes money but this exposes the group to risk so is not a major buisiness for Glencore
Glencore signs agreements with producers to buy their output which it can sell on to fulfil other contracts
Glencore takes advantage of different prices in different markets and moves commodities around to take advantage of them
Glencore exploits price differences between a commodities value now and in the future
Ocassionally a group of commodities delivered together command a higher price per unit than the component parts combined. Glencore uses its sourcing and logistics power to take advantage of this
Glencore is a major producer of grain which it sells
Glencore sells the products it produces for a profit
Aside from supporting their marketing activities, Glencore charges fees to other companies to use their logistics