The $ 52 trillion shadow banks that inflated the commodities boom

After years in the niche, commodity markets are very hot again. The copper, lithium, tin, nickel, iron-ore, prices for manganese, corn, coffee and lumber have all reached historic highs. Meanwhile, those of aluminum, molybdenum, petroleum, natural gas and even the world’s least popular commodity, coal, are trading at multi-year highs.

Commodity markets tend to be very cyclical, mostly bending to the pace of the economy. The price movement of most commodities has always been both seasonal and cyclical. However, the current commodities supercycle is mostly fueled by pandemic bottlenecks as well as age-old tailwinds such as ESG and the clean energy transition. As governments invest billions of dollars in salvage funds into infrastructure and green energy projects to fight pollution, this boom could last for years.

Quite naturally, commodity traders who positioned themselves correctly made a killing in this market. For example, one of the world’s largest physical commodities traders, Trafigura Group, recorded record profits in the first half of its fiscal year, generating a net profit of 2.1 billion dollars, against 500 million dollars in 2020 for a turnover of nearly 100 billion dollars thanks to the rise in commodity prices and increasing transaction volumes. Meanwhile, the world’s leading oil trader Vitol Group broke profit records amid the energy crisis and high volatility in the oil and gas markets.

But as is often the case in financial markets, the opportunities to play in this market have been heavily skewed in favor of deep-pocketed traders while small fries have been left cold.

This is the case because banks are increasingly unwilling to lend to small commodity traders who, ironically, now need much greater capital spending due to soaring commodity prices. Banks such as ABN Amro Bank NV and ING Groep SA cut lending to commodity companies as they redouble their due diligence following a wave of explosions of traders and also because of pressure from shareholders to avoid investments in fossil fuels. To get a sense of the gravity of the situation, consider that banks granted less than $ 49 billion in commodity finance loans to traders and producers in the first half of 2021, which is a drop of 45%. year-on-year and a decrease of 40% compared to the first half of 2019 according to WSJ.

Unfortunately, it was the small traders who were hit the hardest by the lending drought, as it mostly unfolded as usual for giant trading houses such as Trafigura, Vitol and Glencore PLC thanks to their deeper pockets and proven track record.

But, again, as often happens in financial circles, where the big investment banks were unwilling to go, other lenders happily stepped in.

Welcome to the world of phantom lending.

Ghost bank

With a shortage of loans, trade finance is becoming an increasingly important alternative credit investment strategy where a growing variety of shadow banks and investment funds are becoming “the new banks”.

Shadow banks – a term the industry generally dislikes – consist of financial intermediaries who facilitate the creation of credit throughout the global financial system. Shadow banking may also refer to unregulated activities carried out by regulated institutions, including hedge funds, unlisted derivatives and even credit default swaps. A big distinction between shadow banks and traditional lenders: Shadow bankers are mostly exempt from regulatory oversight because these institutions do not accept traditional deposits. Naturally, they also charge much higher rates than traditional lenders, sometimes twice as high.

Related: Energy Crisis Is Soaring Oil, Gas And Coal Prices

These companies saw their activities increase during the current commodity boom, with banks turning their backs on smaller, riskier traders. A good example is one of these funds, Scipion Capital Ltd., which received 24 inquiries from energy and metals traders this year, up from 15 in 2020, while potential borrowers in the agriculture sector fell from 10 to 24 according to WSJ. Their appeal is such that even large traders are now turning to these alternative capital providers: Trafigura recently turned to non-bank lenders, recently issuing a $ 400 million perpetual bond and also successfully raising more than $ 400 million. $ 4.5 billion through two securitization programs for its accounts receivable. .

The elephant in the room is that shadow banks mainly provide loans to underqualified borrowers, sometimes using exotic investment instruments that sparked the 2008 financial crisis, thereby fueling risk in financial markets. You can think of them as the corporate equivalent of emergency loan companies for people with bad credit. But they have become so popular that their assets swelled to $ 52 trillion, a jump of 75% compared to the level of 2010, the year following the end of the crisis, according to the bond rating agency DBRS via CNBC.

Shadow banking appears to be even more prevalent in the besieged oil and gas sector.

Last year, shadow lenders and hedge funds no doubt on petroleum carbon credentials collected hundreds of millions in oil industry debt. Many investment banks have ceded their energy loan portfolios to other capital providers as they seek to reduce their exposure to oil and gas loans. Many of these capital providers have moved to capitalize on oil and gas debt that may have been mispriced by banks, according to Bloomberg.

Fortunately, Wall Street is heating up again in the face of oil and gas companies.

After giving the energy sector a cold shoulder during the energy crisis, Wall Street seems willing to reconnect with oil and gas companies, but on one condition: the funds must be used to pay down debt, not for new drilling. .

Wall Street bought bonds of lower quality U.S. energy companies, lending some $ 34 billion in new debt in the first half of 2021. This is twice as much as the industry collected during the same period last year.

Still, don’t expect shadow banks or their allure to go away anytime soon.

By Alex Kimani for Oil Octobers

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