Bank Of England Tells British Banks To Reveal Their Full Exposure To Glencore And Other Commodity Traders

Moments ago Glencore stock was halted after it tripped a circuit breaker to the upside, soaring 12% and more than doubling from its recent record lows...

... on overnight news the commodity trading giant would cut its zinc production by a third as well as lay off some 1,600 workers in Australia, in the process also sparking the biggest ever rally in the price of zinc.

Annual zinc output will fall by about 500,000 metric tons as Glencore suspends production at its Lady Loretta mine in Australia and at Iscaycruz in Peruit said Friday in a statement. It will also reduce output at McArthur River and the George Fisher mines, both also in Australia and some operations in Kazakhstan. The cuts are expected to result in about 1,600 job losses. Global zinc production was 13.3 million tons in 2014, according to the U.S. Geological Survey, making the reduction equivalent to almost 4 percent of world output.

Bloomberg notes that "as one of the world’s biggest suppliers of base metals such as copper, nickel and zinc, Glencore’s metals and minerals businesses delivered about 30 percent of its revenue last year. The shares jumped as much as 11 percent in London."

Analysts promptly cheered the move:

"Glencore is showing industry discipline by cutting unprofitable tons and saying it is worth more value to leave the tons in the ground,” Heath Jansen, a Citigroup Inc. analyst, wrote in a report Friday. “We expect assets to remain out of production until zinc prices improve materially and stay higher.

This cut is likely to be positive for the zinc market and should be supportive for the zinc price, and net-net likely to be positive for earnings through higher price rather than volume."


“Maybe they are the trailblazer, as there’s the specter of oversupply in many commodities,” James Wilson, a Morgans Financial Ltd. analyst, said by phone from Perth. “If you want higher prices for a commodity, you need to create price tension and to have less product in the market. Glencore’s doing that, though maybe under duress, and it’s something that other big companies should be thinking of.”


“The main reason for the reduction is to preserve the value of Glencore’s reserves in the ground at a time of low zinc and lead prices, which do not correctly value the scarce nature of our resources,” the company said. Glencore is “positive about the medium and long-term outlook for zinc, lead and silver prices.”

To be sure, the latest production cut is not the first for Glencore: the company has already curbed copper and coal supply as it navigates a collapse in raw materials that’s wiped $37 billion from its market value this year.

More importantly, as Citigroup further added the move is unlikely to affect analysts’ earnings estimates for the company or cash-flow forecasts as the operations are unprofitable at current prices.

Simply said, with sales a function of price and volume, and with Glencore aggressively cutting volumes, it is hoping the price increase will (more than) offset the drop in volumes. Which is a big gamble as other cash-strapped miners step up their own production, in the process boosting supply and once again slamming the price of zinc (and copper) lower.

It remains to be seen where the equilibrium price levels off after all these production cutbacks, although if the copper and zinc markets are anything like oil, it is certain that any volume reductions by Glencore will be promptly taken advantage of by Glencore's competitors, because in a global deleveraging and commodity supercycle repricing, he who cooperates while others defect, always loses the game theory.

Still, the basis of Glencore's thinking is probably something very different: as we noted earlier in the week, the company has had no problems approaching its banks with requests for further funding, requests which the banks promptly satisfied knowing that if Glencore fails, it may take all of them with it.

This is about to change.

As we reported two days ago, according to BofA analysts as a result of the dramatic collapse in GLEN equity prices and tumble in its bonds, coupled with the surge in its default risk, the company has quietly become a "systemic risk."

We laid out the conclusions as follows:

  • Comparisons are being made with some financially leveraged companies during the 2008 Global Financial Crisis (GFC).
  • If credit is downgraded, banks could lower their exposure to Glencore both in terms of RCFs & LCs.
  • The high yield market is small and, our credit strategist thinks we might initially see temporary dislocations in a scenario in which GLEN were downgraded to junk.
  • Bank stress tests could start to include commodity trader distress. This could lead to less availability and more expensive bank funding of traders.

It was the last bullet point that was most important, and overnight we got confirmation that Glencore has indeed become a systemic risk from a regulatory standpoint after the FT reported that the Bank of England has asked British financial institutions to reveal their full exposure to commodity traders and falling prices of raw materials amid concerns over the impact of the oil and metals slump. Or, in other words, their exposure to Glencore, Trafigura, Vitol, Gunvor and Mecuria.

The Bank of England’s Prudential Regulation Authority, which was set up in 2012 to ensure the “safety and soundness” of banks in the wake of the financial crisis, sent the requests to the UK’s big banks in the past week, according to three people with direct knowledge of the matter.

And just like that Glencore is in the same boat as China and Greece: the PRA move that mirrors similar inquiries it made earlier this year about the banks’ exposure to Greece and to China, was prompted by a sharp drop in the shares of Glencore, the biggest publicly listed trading-house-cum-miner at the start of last week.

The damage control came fast and furious, with the FT quickly adding that this demand for exposure "was not provoked by any immediate concerns of a default, a person familiar with the matter said, but it was checking that banks knew what their exposures were to individual commodity houses and that they had examined the wider knock-on effects if a large commodity trader was to collapse."

But wait, didn't a paid-to-scribe UofHouston "professor" recently claim that commodity traders were "not a systemic risk"? The Bank of England seems to disagree.

The FT also adds that "the PRA also wants to ensure banks — many of whom trade oil and metal themselves as well as financing commodity dealers and companies — are prepared in the event of a prolonged slowdown in the sector."

A person familiar with the move said: “This is not something we do every month, it is situation-specific,” adding it was a specific response to the recent share price moves of Glencore and other commodity trading houses.

Why is this a milestone development for Glencore? Because as BofA explained, now that Glencore is clearly in the central bank's microscope, banks will be much more careful about how much liquidity they provide the commodity-trader with $100 billion in counterparty exposure:

Recall from BofA:

GLEN had an unencumbered asset base of over US$90bn in property, plant, equipment and inventories at the half year. However, for bank investors and regulators, after the crisis, gross nominal exposure is a key metric – including committed facilities. We believe many banks may now be more carefully reviewing their exposure to the commodities complex. Glencore’s banks span the globe, with 60 in a recent financing. Glencore has stated it has locked its financing in for an extended period, but a desire to hedge would be powerful at the banks, as likely that regulators will include commodity and energy exposures in the next stress tests as it is a stated area of focus. These stress tests typically take gross exposures and assume elevated loss-given-default - a potential 5x capital uplift. A system positioned one-way on a credit has historically tended to keep spreads high; implying rising debt costs which are likely to put pressure on credit quality: convexity is alive and well.

What does this mean for Glencore, and its stakeholders? It means that today's rally is certainly welcome for a company which recently lost 80% of its post-IPO equity value. However, the long-term prospect remains nebulous, and as we said first in March of 2014, ultimately a bet on Glencore - in either direction - is a bet on China. If China fails to create a solid economic recovery, and push commodity prices higher, Glencore is merely buying time even as its cash flow dwindles, as its asset base shrinks and while what few unencumbered assets it has become encumbered with liens or are pledged, thus eliminating the company's ability to boost liquidity when it needs it most.

For now Glencore has avoided the worst, but now that it is a "systemic risk", should there be another major swoon lower in commodity prices, it may not be so lucky next time.