Skyrocketing commodity prices and glaring margin calls are forcing traders to scale back, wiping liquidity out of markets and exacerbating price fluctuations, according to some of the world’s largest trading houses.
“We are clearly seeing that liquidity in terms of being able to find buyers and sellers in distressed or highly volatile markets is getting less and less,” Engelhart Commodities Trading Partners Chairman and CEO Huw Jenkins said at the FT Commodities Global Summit. in Lausanne, Switzerland.
Engelhart halved his positions in the last six or seven months, he said. The company is not alone. As commodities fluctuate wildly, traders and industrial players are struggling to keep up with massive cash requirements to back their positions or create new ones, which is driving out market participants.
The drop in liquidity increases volatility when prices move. Benchmark European natural gas, also known as TTF, surged as much as 34 percent on Wednesday as Russian President Vladimir Putin prepared to demand ruble payments for the fuel. That was just the latest example of the price swings triggered by the Russian invasion of Ukraine.
It is not just the markets for fossil fuels that have become unusually volatile, but also those for other goods that underpin the global economy. Nickel prices have continued to swing wildly on the LME, even after the bourse halted trading for days after the metal soared 250 percent during two trading sessions in early March. Wheat futures in Chicago rallied past the trading limit for back-to-back sessions earlier this month.
We’re in the middle of a storm now
“We are in the middle of a storm right now,” Gunvor Group CEO Torbjorn Tornqvist said. “A lot of parts got hurt at TTF. And then they realize they just can’t get in with this kind of initial margin,” he said, referring to benchmark Dutch gas futures.
Commodity traders’ balance sheets are also under pressure. Reliant on credit from banks to finance shipments, traders are reaching funding limits when prices rise sharply, reducing their ability to take advantage of arbitrage opportunities.
“It’s just a general concern across the market that we’re losing share,” Vitol Group chief executive Russell Hardy said. “Overall, capital across the market is very spread out and you can’t do as much as you could have done a year ago because the cost of doing business has gone up.”
The growing volatility may increase as some participants stay out of derivative positions and it becomes more expensive to place new ones.
Several trading house executives also said there has been a noticeable shift toward companies placing over-the-counter commodity hedges and bets through banks, rather than exchanges.
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While the costs associated with trading commodities are rising, higher prices also mean that traders, especially those with large physical books, need additional credit to finance the shipments they ship around the world.
That sparked a search for larger lines of credit; Mercuria Energy secured US$2bn from banks earlier this month, while Trafigura Group has twice secured new packages in as many weeks.
“We have to measure our activity and our appetite for risk with our financing capacity. It’s as brutal as that,” said Frederic Barnaud, group strategy and commercial director at Mercuria.
Ultimately, the squeeze is leading to increased caution.
“This combination of very high volatility combined with a significant increase in margin requirements, combined with significant air pockets where liquidity in the markets disappears, means you need to take an extremely conservative approach to risk management,” Jenkins said of Engelhart.