Volatility leading to elevated importance and scale of commodities trading

Source: press release, 30 January 2023

Commodity trading value pools have grown rapidly in the last 5 years (source: McKinsey & Company)
Commodity trading value pools have grown rapidly in the last 5 years (source: McKinsey & Company)

The latest analysis from global consultancy McKinsey & Company reveals a buoyant market for commodity trading, with new players entering the market to chase trading returns, due to high volatility. Driven by the energy transition that is increasing structural volatility, disrupting trade flows to open new arbitrages, and fundamentally altering commercial relationships, it will call for a new type of trader, with new capabilities.

The future of commodity trading report identifies the geopolitical, macroeconomic, and environmental factors causing markets to fluctuate and supply chains to falter at present and in the future, as well as the models players can implement to win, as they compete with a rush of fresh entrants and more adaptable traders.

Global commodity markets remain vulnerable to potential disruption from both one-off events and longer-term disturbances. For example, the invasion of Ukraine has meant reduced Russian supplies to Europe, causing the EU to rely on alternative sources from longer distances. McKinsey analysis details that over the longer-term, as the world becomes increasingly electrified and invests in alternative fuels, incentives will be created for regional supply networks, for example, countries with high demands for traditional commodities such as oil, coal or LNG could enact their own capabilities to produce and consume hydrogen.

Roland Rechtsteiner, Partner at McKinsey, says, “In the sector this year, we will see a heightened interest from organisations into increasing the sophistication of commodity trading. To achieve this, organisations want to understand how they can increase the commercial optimisation of their entire asset park and take part more profitably in the trading sector. Further, how can they be closer to market developments, to price discovery, as well as to customer requirements.”

Joscha Schabram, Partner at McKinsey, says, “Commodity trading value pools have almost doubled from USD 27 billion in 2018 to an estimated USD 52 billion of EBIT in 2021, with the market enticing new entrants, thus our analysis suggests that the market value will continue to grow. This report highlights the considerable impact possible through commodity trading in recent years and the underlying developments responsible. In the coming years, the effect of these developments and trends could be magnified, resulting in even more value at stake, which will then attract new players.”

To seize these opportunities, McKinsey outlines five factors that will be critical to the success of commodity traders:

  • Prioritise customer centricity as the energy transition reshapes commodities. Customer centricity is particularly relevant for new commodities such as sustainable aviation fuel. Customer needs, willingness to pay, and the improving economics of new technologies will determine the development journey of these new commodities.
  • Embrace the industry’s shift to short-term markets. The current market environment has intensified how customers perceive risk. Producers will revert to short-term markets, because their shareholders will not want to endure the high costs of long-term positions or the negative impact from the loss of flexibility.
  • Invest in decarbonisation as an asset class to harness the “green premium” as a potential source of first-mover advantage. The green premium’s evolution and the opportunities it creates for players will be closely linked to how voluntary and compliance carbon markets evolve. Players must accurately track the carbon exposure of their products and cargos with their customer’s willingness to pay. In the future, this tracking could extend past carbon to a holistic view of multiple ESG elements.
  • Rapidly ramp up trading capabilities, as scale is a critical factor. Scale enables players to achieve better returns, ensures global access to customers, and secures more competitive financing.
  • Ensure the trading platform and operating model balance efficiency and agility to enable growth, especially considering talent shortages. Growth from increased customer centricity can be restricted by the platform and operating model’s inability to capture and report on complex transactions. Changes need to be made to ensure the ambitions of players is not limited by their platform and operating model.

While the duration of this combination of cyclical bottlenecks, price transparency, and redefinition of commodity classes is uncertain, its effects will likely be felt beyond the short term and to different degrees. To navigate this, McKinsey indicates that many players will gravitate to one of three possible models:

  • The global smart-scale trader will be driven by digital enablement, automation and optimisation to pursue thinner margins.
  • The niche trader mastering complexity will need to develop and sustain a competitive edge based on either customer centricity or distinct technology and analytical capabilities to stay ahead in markets where scale is less relevant.
  • The tactical trader-investor will capture value by taking positions to solve the supply and demand imbalances prevalent in commodity-based industries, potentially willing to go outside traditional trading mandates.

McKinsey’s findings in detail are available here.