← The HC Commodities Podcast
The HC Commodities Podcast
Competing to Trade: Roland Rechtsteiner
00:53:31
What is the future of commodity trading? Is volatility here to stay and thus the profit pools available continue to grow? What will the market structure look like in 10 years and who will be the privileged few that have built, or are building, commodity trading platforms to be able to capture that future? What will that future look like? Who will participate and which category of participant will have the greatest market share? And what will the teams and skill sets and people look like participating in that world? Our guest is Roland Rechsteiner, partner at McKinsey and the global head of their commodity trading and risk practice.
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Roland Rechtsteiner
Foreign.
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Paul Chapman
Welcome to the HC Commodities Podcast, a podcast dedicated to the commodities sector and the people within it. I'm your host, Paul Chapman. This podcast is produced by HC Group, a global search firm dedicated to the commodities sector. Today we're talking about the future of commodity trading. Is volatility here to stay and thus the profit pools available continue to grow. What will the market structure look like in 10 years? And who are the privileged few that are capable and able already have built commodity trading platforms to be able to capture that future? And what will that future look like? Who will be the participants? Who will have the greatest market share and what will the teams and skill sets and people look like participating in that world? Our guest is Roland Rechtsteiner, partner at McKinsey and the global head of their commodity trading and risk practice. As always, you can really support the show by leaving us a positive review on the platform we're listening on and I hope you enjoy the episode. Roland, welcome back to the show.
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Roland Rechtsteiner
Thank you very much Paul for having me. I'm glad to be back.
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Paul Chapman
Yeah, it's actually I was just looking back, we last had you on in early 2022 and you were talking about a paradigm shift in mining and how that was going to play through into their need to develop a trading capability. That's certainly a narrative that is playing out as we speak. So I'd encourage people to go back and listen to that and there's probably a good pointer to why they should listen to you in this episode. And today we are taking a long view and really your thesis around where the commodity markets are in terms of cycles and volatility and essentially whether we have moved from a decade long cycle that we've historically seen to a different regime. So the why of that and going to talk about the consequences, but maybe you can frame that the thesis for us perhaps how commodity markets have been historically and shape up to what you think is changing.
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Roland Rechtsteiner
So if you look back how the commodity trading profitability or profit pools have developed over the last 15 years, we obviously had the super cycle in 2009 and then after that we had a period from 2010 to 2018 almost where markets were very flat and we had an average global profit pool of around 3035 billion a year. And then what happened is we had obviously in 2019, 21st was corona, the COVID crisis, but then in 22 was the Russian invasion in Ukraine. We had this extreme growth of that market which was up to 100 or more billion in terms of EBIT for the global commodity trading sector that came down over the last few years and we are centering 2024 was around 70 billion and we're expecting something similar for 2025. So we basically are on a new normal now. And that new normal is more than twice as big as what we had before this super cycle of the last few years. And I think that's the interesting topic to discuss because we have on the one side we had obviously these one time events that were exceptional. But at the same time we also have through the energy transition, a policy induced change of supply and demand which is constantly having a significant impact on the volatility of the markets. And that's kind of in general driving a uncertainty and volatility in the market and therefore drives trading opportunity, but also risk management requirement. And then on top of this we obviously have increasingly also more volumes and participants in trading markets and through this volume increase obviously also the increase in overall margin being produced.
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Paul Chapman
Yeah, there's so much to unpack there. So essentially this new normal at double the revenues that we saw in the 2010s, I guess 2019 is probably quite an instructive year to look at. Right, because that's prior to these huge exogenous shocks of a land war in Europe and a global pandemic. What did we see in 2019 that meant that commodity prices, well, we saw an increase in volatility, an increase in opportunity, an increased need for risk management in 2019. And how does that sort of compare to say 2025 and so forth? What structurally is going on? That means that we've got this sort of level set higher than where we were.
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Roland Rechtsteiner
So there's, on the one side we have quite a few new entrants into the trading sector. So you think about national oil companies, you think about some of the mining players, you think about a lot of the renewable companies that have built energy management capabilities. In the power sector you have increasing LNG volumes and much more liquid markets and trading activities now. And on top of this you have the, through the energy transition you had quite a few changes where there was a significant focus first on the hydrocarbon side, then it moved massively into renewable energy. Now there's a heightened focus back on the hydrocarbon side. And I think on top of this, what you have is, and you can see that already happening right now, you have very different S and D fundamentals because of for instance, underinvestments on the oil in the oil sector. And that's obviously driving constantly these uncertainties around what's the merit order of technologies and of energy classes that actually will drive the overall, will drive the will power the world in the future and that drives the trading activity.
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Paul Chapman
I mean, we talk about sort of the 3ds decarbonization, that's the energy transition. We're going to come on to digitization, which is technology piece, but also that de globalization element. Is it fair to say? At the same time you've had kind of a growing rise in commodity markets. More markets are becoming liquid, more markets are becoming developed. Talked about LNG just there as an example. You've also had kind of a huge shifts in global flows of commodities dating back to 2019 and sanctions on Russia 2014 even. Is that contributing to this? In fact, the more stable global trade that we all relied on in the 2010s and the ever marching forward of free trade and globalization, that trend is ending and that's causing these opportunities and these risk management shocks.
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Roland Rechtsteiner
Absolutely. I mean, if you think about when the sanctions started on Russia in 2022, we had a massive, massive fundamental global shift in terms of flows. Where before that we had basically crude and products going the shortest and cheapest way, predominantly through pipeline systems. And suddenly we had a complete inefficient, much more seaborne crude, much more seaborne products had to move around the world. And I think that had a massive shift. That's also why we did see that in 2223 the trading activity go up so much and therefore the profit ports, because so much rebalancing of global systems had to happen. And obviously the owner of prompt inventory and of logistics capacities would actually benefit from that. So that's been one of the major drivers. And I think this is also in general, the geopolitical changes that we see, and we will probably see over the next years also constant change in terms of where flows will go, what flows will be moving. And that drives the uncertainty, that drives volatility, and that will drive also trading profits going forward.
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Paul Chapman
Yeah, because this is quite a profound thesis, right? So we're at a sort of an inflection point. And the question is, are we in 2014 or 2013 or whatever it might be, and we're kind of two years into a long sort of period of less volatility and a bit of a slump for the commodities sector profit pools, or this thesis, your thesis, which is not only have the levels reset at a higher level, inflation adjusted, I should add, you know, almost double what they were in the last decade. But your thesis as well, if I'm right, is that we won't be waiting around for another 10 years for the next big spike. We're going to see larger spikes more frequently, greater magnitude greater volatility on a much more frequent timescale. Is that a fair analysis and can you dig into what that timescale looks like and why?
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Roland Rechtsteiner
Fully agree to the thesis you're outlining, Paul. What we see is that as the world has changed we see a few drivers that will continue to drive the volatility. First of all, this is geopolitical impacts that we see on global basis and that we expect to see at least on the same level as we see it right now happening constantly. I think on top of this, the continued energy transition that's going to continue to drive the S and D changes and certainly related to that also the current underinvestment on the hydrocarbon side we see and then thirdly we see increasingly more players seeing the need to participate in trading markets because the for risk management purposes but also for the ability to maneuver the changing landscape. And on top of this certainly get their fair share of the wallet based on their own molecules. And that together will drive more activity and will drive increased participation and increased value pools. But more importantly is also these drivers will change more often and therefore drive more cycles and shorten cycles in terms of these peaks that we see in trading. To give you one example, if you think about historically we said we had all, every 10 years we had like a, a massive cycle, you know like the dot com bubble burst around 2000, then we had the super cycle 29 coming down with the financial crisis. Then we had the COVID plus the R invasion and all that was more or less always every 10 years. But if you think about what we foresee already now, if you think about current oil markets, the underinvestments we're seeing, we see currently a market that is oversupplied and that's reflected in the oil price. But when you, when you look into the different models around S and D for oil over the next years, you can see and also our models show that, that somewhere in 2026 we will see that S and D switch from an oversupply to an undersupply and therefore into 27. At one point in time we will see price increases and we will see, at least that's what the model shows, price increases as well as tightened markets. And that again could actually drive, could be the beginning of the next very strong cycle.
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Paul Chapman
Yeah, yeah. And it's at the same time we're sort of in this world of the poly crisis at this, you know, and poly opportunity, poly, you know, there's just so much going on. But we are going to, so we're going to second half of this discussion. We're going to talk about what the world will therefore look like as this plays out over the next decade, which is going to be a profound shift. I just want to spend a moment on that sort of interesting element of the self fulfilling cycle of. We have seen new entrants clearly, we've seen the funds and so forth. But the more fundamental story has been the strategics, miners, producers, refiners, processors, seeing the need, the opportunity, well, the opportunity of building out commercial functions at the same time almost now the necessity to manage that downside risk you, you pointed to. So we've, you know, the, the rise of these new entrants that itself is therefore driving, you're suggesting, driving the, the commodity wallet, so to speak, because there's just more, more flows, more opportunity. Is, is, is that a correct analysis? And can you just dig into that a little bit?
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Roland Rechtsteiner
If you think over the last five, six, seven years we've seen as you said, many new entrants that entered into the commodity trading space, particularly the ones that have previously predominantly marketed their volumes as producers, be that in the mining sector, in the oil sector like NOCs, but also on the power side. And we have also seen a lot of financial players in the market. So we have seen the whole rise of data driven traders, specifically in power and gas. We have seen obviously the hedge funds playing very heavily in the markets as well. And that basically in itself, you know a provides liquidity but also certainly can also drive to a certain extent volatility, but specifically drives the value pool up in general. I think when you now think about what's going to happen going forward, I think you will see certain players being privileged to participate in these massive upswings. And those are obviously the ones that can put a lot of bar and working capital against market structures in a very short period of time. And we've seen this in 20, 21, 22, 23. Of course those were predominantly merchant traders as well as the hedge funds. They actually took the majority of the growth in this market and banked the profits which, which sometimes was four, five times what they had in previous years. If we now assume that going forward we have multiple and of course the hedge funds basically did exactly the same. Now if we now assume going forward we have more of these events, we will obviously see these players being able to significantly increase their average profits over the years over a decade compared to the other players, and then in itself will put them in a very favorable position to actually gain market share going forward.
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Paul Chapman
Yeah, yeah. And that will have a profound impact on the shape and the participants of the market and as you say, the privileged few. And to be one of those privileged few is about. About building it now, which we'll come on to. Just one, one, just a couple of elements here. Firstly, there are. This is. This is a thesis. There are elements to it that could accelerate it and make it even more volatile, you know, on shorter frequencies or intervals and greater magnitude of volatility. There are others that could dampen it down, just staying on, I guess the ones that could dampen it down before we talk about the ones that can accelerate it. There is also a scenario here where things get so fractured, so broken in terms of international trade. We might be in a different world of problems here, but actually we're seeing a global nationalism. We've already seen in peak food prices or in the grains and so forth, where you see significant government intervention when things look like they're getting out of hand. And we're already seeing that in Europe in terms of legislative response to those high prices. Is there an element here that. This all sounds great, but we could see significant government intervention. We already are seeing it. That could impact the commodity market's ability to manage and operate and handle that volatility and sort of detracts from the thesis here about companies that can build capabilities to respond to it.
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Roland Rechtsteiner
I think there's certainly a risk to that. And we can see often that policy changes also, I would say national interest can actually change some of these, some of the way, some of the other ways of some of these commodities being traded. Our hypothesis here is that the world is globally more connected than ever when it comes to trade of commodities and the requirement to globally actually optimize around prompt inventories. And I think you also have to look at it commodity asset class by asset class, where it will be very different. But the way we actually foresee this at this point in time is that we have. We will have maybe different trade routes. We will have different combinations of regions, how they trade. But in general, our systems are set up in such a global way that without the global trade in the future, it will be very difficult to sustain. And that's why, from our perspective, it's much more likely that the global trading activity will increase. It will change. It will change also from how it needs to deal already today with regulation, with sanctions, with policies, et cetera but the global integration continues to stay.
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Paul Chapman
Yeah. And the sort of allied element to that though is as well is that there's also sort of depends on the nature and the course and the length of the energy transition. Because fundamentally the energy transition is about moving from a fuel to a technology and moving from for the most part, with the exception of metals, from kind of a global flow of hydrocarbons from places that have lots to those that have none or very few, to localized production of energy. Right. There's a sort of scenario where with a few nukes and a lot of solar and as long as you've got the copper and you know, some of the rare earths, you. The global trade around it and commodities can. Will slow dramatically. Is there any in your thesis, how long does this long period of volatility and cycling occur for? And that might be too difficult question to ask.
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Roland Rechtsteiner
I think it's a good question. I think. I wish we had the answer. But I think what we see is when you look at all the scenarios around the use of hydrocarbon and the demand of hydrocarbon, there's still basically a plateauing element that we see right now. Hydrocarbon use currently is still growing, whether this is oil, gas, even coal. But what we definitely see for the next 10 years, there will be no massive change to this. And then obviously we will see changes in terms of the hydrocarbon flows, but not necessarily on the gas side. Very quickly, if you look at some of the scenarios, basically you see that gas consumption 20 years from now is on the same level as it is today, obviously with a peak in between, which basically mean there's quite significant global trade ongoing. Because we certainly believe that LNG will continue to grow and continue to support actually the global integration of gas and power markets as well. Yeah, you see the same on the metal side. You see the same on the metal side. Yes, there's way more requirement around like right now, you know, you look at energy transition metals, you look at some of the rare earths, etc. But the global trade we certainly see to continue massively on that front as well.
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Paul Chapman
The energy and resources sector is experiencing unprecedented change.
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Roland Rechtsteiner
To help navigate this change and capture.
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Paul Chapman
Its opportunities, HC Group launched Enco Insights, a global advisory network dedicated to the sector providing senior advisors and subject matter experts to investment and infrastructure funds, law firms and corporates. Enco Insights leverages HC Group's 20 years of connections in energy and commodities to give clients the expertise they need when the stakes are high and insight matters. Learn more@encoinsights.com. Let's talk about that privileged few. Right. And today, and you and I, we're privileged enough to share some breakfast quite frequently and talk about these elements. And one thing that really hit me from our last discussion was of course, you've got this group of organizations that have the capacity and have the, the board support, the executive committee support, and the understanding that they, this is a function and a capability they need to build out to manage future risk, but also capture those opportunities and frankly, stop handing so much money over to the trading houses. I said it. You don't have to agree, but you know, clearly a part of it. Right. One of the things at the same time that's going on is obviously AI, and that's a nebulous term, but essentially a huge amount of innovation on the digital side, the capacity to process information, to project, manage information, that itself seems to be having a, or quietly having a revolution on the costs, the huge barriers to entry and time it takes to stand up these commercial teams of whatever degree of risk you're willing to take. Can you, can you help us understand how profound you think AI is going to be on allowing organizations to accelerate building out these capabilities?
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Roland Rechtsteiner
Absolutely. Maybe. Before we talk about AI, let's quickly reflect on what's required to actually win in these trading markets in the future. And I think when we think about the different players in these markets, there's actually three core elements that we say what you need to have in order to be successful a few years down the road. Number one is actually flow. So you need access to assets. Number two is capital, both in terms of risk capital and working capital. So you're able to participate and you're able to sustain the high volatility. And the third one is the sophistication in terms of your global system, how you trade and the insights you have. And obviously a part of the last one, because we spoke about flow. So a lot of players that have their own assets, they come into this market for a good reason and they should get their fair share of the markets and they do that. On the capital side, we talked about how important capital is to get access to the alpha when the markets are getting volatile. But the third thing is about the sophistication, which really is going to make a difference. So this is about the size of the activity and the capability that you have built up. But now AI coming into this as being a big game changer. So we saw that, we saw that specifically over the last years, I would say in, specifically in power and gas, where we saw these data driven trading companies suddenly scaling up from 100200 million of margin into the billions of margins as they could very much profit from short term trading in power as an example, be that in Europe or now actually be it in the US and extending into places like Japan, Brazil, etc. Secondly we saw obviously some of the sophisticated hedge funds, how they could build up AI capabilities to really trade across all the commodities in these markets, build very successful models and create huge margins on the back of this, purely based on data model and data scientist centric trading activities. What we see now happening I think is two elements. I think first of all the data driven traders are now understanding that increasingly they need to have more insights from fundamental physical trading activities. And that's why you see some of the hedge funds or data driven traders actually investing into physical assets to get the real insights. And on the other side you see the physical trader massively increasing their capabilities and sophistication on the AI side, the digital side. So most of the players today have their own data scientists. They have they building predictive analytics on front office applications on operations etc. And now more and more focus on actually how to use for instance agentic AI to reduce mid and back office cost. These activities, there's no trader that's not looking into this. Many have already implemented capabilities and the financial impact that these capabilities are having on the trading activities are massive and just to be a increase as we look forward.
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Paul Chapman
Yeah, fascinating. So not only can you capture what you're using, all that, the predictive element of technology to be able to make better trades and do it faster than your competition, we've covered that significantly. We've done an episode a couple of months ago precisely on that. Can you just take that? Because it is an important part here and not to scare anyone, but what is the logical conclusion of using agentic AI, particularly in the middle and the back office?
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Roland Rechtsteiner
So we're going to publish our next annual report on the sector probably towards the end of February and there will be one section focused on this because what we can see is that even with today's technology you can achieve like 30% cost savings in your mid back office operations once implemented. Assuming technology develops as we expect it to develop over the next two to three years, we see these numbers going way north in terms of efficiency gains that you can achieve in your trading operations. But that's not only, that's not only in terms of cost, it's also in terms of speed where you will have a massive impact. How you can actually operate.
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Paul Chapman
Yeah, yeah, we'll wait till your February paper. I won't, I won't jump the gun on some of those conclusions and look forward to that. Okay. So that's certainly a trend that is going to accelerate participation. You laid out that three very clearly. Assets. And we absolutely see that comment of the hedge funds getting into the physical space, capital and sophistication. What I think is interesting is actually when it comes to technology, a lot of the strategics, they're very sophisticated in terms of technology when it comes to the upstream elements of their business, for example. So it's not like this whole world is new to them, it's just translating that into the, into their new, new or developing commercial teams. One question is on the capital side, right? And maybe this is, you'll have to, to help me through with your eloquence and insight and I might be asking quite a naive question, but you know, I get the fact that if you're a big NOC or whatever, you've got tons of money and, and you've got a low borrowing rate and all that great stuff. But the way that the trading houses have cleverly used their capital and it's part of why we've seen such consolidation in the trading houses is obviously they've developed these huge revolvers and bank lines and so forth, but they use that capital, they are lending to small participants to get their commodity offtake.
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Roland Rechtsteiner
Right.
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Paul Chapman
Would you, is that an area that these strategics, these majors, producers, would they ever start doing that as well? Do they have to do that to compete? Do they have to get more sort of willing to do funky stuff with their money, so to speak.
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Roland Rechtsteiner
So there's a few elements in this question, Paul, and I think the first one is I think we need to separate two types of capital. The one is actually almost like capex or the ability to acquire and build out your system. I think that's one element. And the other element is how can you lever yourself up to actually get access to a lot of capital in the short term also at a low rate? Because I think these two elements are really important because the ladder is really important in these times when we have significant upswings and the ability to put risk, to go risk on and put a lot of capital into it. And here the one group of players that are challenged are actually all publicly listed organizations because it's much harder for them to significantly level them up because the short term debt actually is being consolidated in the balance sheet and therefore has an impact on any type of rating covenants. That's why we have seen for instance in 21, 22, 23, we have seen specifically predominantly private companies basically being able to participate in this and others being getting quickly to the limits of what they could do. So that's one element. The other element is how do you get access to flow and how do you use capital to get access to flow? And I think here's two things. So first of all, getting access to through I would say sophisticated origination, which could be prepayments, which could be equity for supply rights or equity for offtake rights. I think those are, those are ways of extending your system that we see already for a long time and in all. And also that's not purely the merchant traders. That's also being done specifically by the IOCs and some and obviously the large power traders for a long time. Getting access to the capital to do this in the big time obviously is getting much harder. On top of this, what we right now sees when it comes to. And you see that in the M and A deals that are happening, most of the retail businesses that get on the market are being acquired either by merchant traders or by NOCs. When you look at the refinery sector, about 70% of all refinery deals over the last four years have been done by merchant traders. Which basically shows you where the capital sets that can be deployed into these markets. But why is that? That is also because the merchant traders need to increase their flows, need to increase their captive flows because it's harder for them to get access to optionality from producers or from refiners. Because these players develop their own trading capabilities. That's why they need to build their own system. And I think that's actually changing market structures quite a lot. And what we see now is obviously that the NOCs, but also other players, you know, in the power sector are pushing much more into how you can build out your system actually through these more sophisticated origination plays. Because that's the way how you can build as long as you got access to capital, how you can build your global system.
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Paul Chapman
Yeah, and this plays into our thesis we've discussed multiple times around actually the. The most valuable player of the future is going to be the originator as much as the technology and trading goes into the short term and sort of some of those opportunities become sort of harder to capture. It's actually really those long, the big plays done by the originators that are going to be the real drivers of value and arguably are today. But that's probably a separate podcast. It does Lead us on to I guess where McKinsey and HC intersect often is on sort of when it comes to talent. There is a story here again about kind of that idea that there's a window to build these capabilities. And yeah, okay, fine, I'm talking my own book a bit. But like there is a window and part of that window is shaped by the fact that there is a limited talent pool out there in that the 2010s very little investment was going into building new teams. You had huge consolidation. So the overall number of seats were fewer and less people were being developed. And we're now, and we've written about it for our annual review that by the time this episode goes out is probably about to be published, but on a great retirement cliff, by which I mean we're kind of seeing the class of 92 retiring out rich right now.
- [32:14]
Roland Rechtsteiner
Right?
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Paul Chapman
Or they already have done and they're not leaving behind them a bent strength in depth of commodity traders and all the, you know, the various skill sets you need because of that volatility in the market. A long way of saying that at the moment, you know, if you're not building out your commercial teams to capture this opportunity, whether you're an NOC or an IOC or whatever it might be, you know, without a very strong message about why and how you're going to win, you might be shut out simply by the fact that there being very limited talent available for you to do this. Even if you want to fully agree.
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Roland Rechtsteiner
I think talent specifically in some areas you mentioned it, like senior trading capabilities, origination capabilities, specifically analytics and data science capabilities are definitely the ones which are most important to build these businesses alongside with operations and are very hard to get right now because of the growth of the sector, the number of seats that went up, but also kind of just in the case of AI data science, just like limited talent availability that has the capability that's actually required. And on the origination side, as this topic becomes more and more important, that's an area where we certainly see also in the market that it's getting hard to find the right people. I think one of the ways a lot of new entrants are currently thinking of and what we see increasingly happening, how you enter into the trading space is actually not necessarily just an organic build out. There's more and more players are certainly looking at M and A and we've seen a few quite successful M&As happening for players that hadn't had trading operations before. But also we see increasingly a focus, for instance off joint ventures between, you know, producers or downstream players with established trading companies because that's obviously a much faster and a much less painful route to market as building it organically.
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Paul Chapman
Yeah, yeah. And that is I guess, the element I wanted you to hit on because that is going to be important in how that future market might look. And we're already seeing that. Right. And that is, I think, a function of talent. It's a function of how long it takes to build these capabilities and all the rest of it that we've discussed and those privileged few that have done it or doing it right now are going to be well positioned to even offer those services to others down the line. And that's where we might see some surprising joint ventures develop. But let's wind the clock forwards to. I know you pick a date, but 10 years hence you've made a compelling argument about the fact that we're going to see more volatility more often, that we're going to see continued increases in commodity flows and the need to risk management in the commodities world and increasing recognizable, increasing number of participants, but a changing nature of those participants. What does the market look like in 10 years time? What's the market structure then? How different is it today? I want to spend some time on this.
- [35:25]
Roland Rechtsteiner
I think it's a really interesting discussion and we did some analysis on this where we played with different scenarios and if you go back to kind of what are the fundamental drivers around flow capital and sophistication and you think about how the market's going to shape out as we discussed, with different, you know, with more cycles, more cycles and the ability also to participate in these cycles. Our perspective is, and again, it's different commodity by commodity. But in general, our view certainly here shows, and the analysis shows that we will see a significant increase in market share globally by the merchant traders. Why is that? Is because they have the sophistication, they have the access to capital and they use the excess capital they are creating through shaving alpha during these very volatile times, as we've seen in the last few years, to invest into their own asset bases. And we've seen some very large deals, but we see constantly deals happening. And I think this is something that will continue. And every time we have such a cycle again they will actually fill their bank accounts to be able to do these investments. And I think that will enable them to massively grow their market share going forward. I think secondly, we think the, the NOCs that are starting trading or that get into trading or have built trading Businesses as they are growing their global asset basis as well, they will have the ability because they are less dependent on ratings, etc. They will be able to allocate the capital, they have the flow, they will increase the flow and that will actually also help them to gain market share going forward. And then we have some very large players out there, whether it's in oil, whether it's in mining, players that don't necessarily already significantly optimize their value chains through trading activities and activity in the market. So there's a lot of intrinsic optionality that's currently not being monetized. And as these players are currently quite a lot focused both in oil as well as in metals, to build these capabilities, we expect quite some market share taken by these players as well going forward.
- [37:52]
Paul Chapman
At the expense of whom? So let's just go back to those traders, the merchants. I mean a, there's, there's four of them, you know, or four and a couple of others. Not to upset anyone, but you know, they already have a massive market share. Who are they? You know, market share, unlike volume, is a zero sum game. Who are they taking? Who, who's losing market share 10 years hence?
- [38:14]
Roland Rechtsteiner
So it gets back to the three elements that are the success factors to sustain in trading and growing trading, which is flow, access to flow, capital and sophistication. When you think about who are the players that are maybe losing flow because of divestiture of assets or have difficulties to access capital within their organizations or in the markets, or the players that are maybe too small to actually do the massive investments that are required into artificial intelligence, etc. And therefore built their sophistication further out, those will be the ones that will struggle and will have to think about what are their strategies to continue to win in these markets. There's a lot of players out there. Be that, you know, established all traders or be this established power traders that fall into that bucket and those will have to think now very carefully around what is their right to win, which areas they have to play and how do they focus on these areas to build strategies that sustain and help them continue to be strong participants. Hello, I'm David Hunt, founder and Managing Director at Hyperion Search. Founded over a decade ago, Hyperion Search has helped organizations from major utilities to startups recruit their leadership teams and key individual contributors to accelerate both their growth and the energy transition. Our three main verticals are renewable power, energy storage and the mobility, the energy transition and the talent that delivers. It has been our passion since day one to find out more visit hyperionsearch.com or listen to my Leaders in Clean Tech podcast available on all platforms.
- [39:54]
Paul Chapman
And that brings us slightly to a more profound question which is has this gone from a nice to have to a must have? And I asked that in the sense of in the in 10 years time, is there a role can boards elect just to market their equity production or will they be forced, as a result of how the markets have shaped, to enter, you know, the alternate into a JV of some sort?
- [40:23]
Roland Rechtsteiner
Right.
- [40:23]
Paul Chapman
Is it, is that a fair question?
- [40:25]
Roland Rechtsteiner
Absolutely. I think it brings us back to the very beginning of the conversation where we talked about how markets are changing and markets are definitely getting more volatile and also more uncertain. So the ability to navigate regional versus global markets, to navigate different counterparties, and the ability to navigate the financial risk related to your own operations is just increasing. Which basically means the need for sophisticated risk management capabilities and price discovery market access capabilities are just increasing. Hence the majority of the players today, which are not yet in trading activities, realizes that they need to, not only for additional margin, but for pure risk management purposes, need to participate in these markets. That's one of the factors. Why to your question, a certain level of trading capabilities and trading can mean a lot of things, but a certain level of trading capabilities so that you're able to have proper price discovery, proper risk management and proper pricing and structuring capabilities to negotiate your contracts eye to eye will be very important. So this will demand that you build these capabilities. And that's why pretty much all organizations that are in commodity markets are thinking through how to build this. This is even happening on national levels where governments or associations are thinking how.
- [41:58]
Paul Chapman
To how to do their equity slices of it exact.
- [42:01]
Roland Rechtsteiner
Exactly. And then on top of this is if you're in a market that's already very sophisticated, let's say you're a downstream player in oil. If you don't have trading capabilities and get the additional 2 to 4% of return on capital employed from your trading capabilities, but all your peers are getting it, it will be much harder for you to have the discussion at the investor stay in order to when you get compared to other portfolio performances. And I think these two factors will definitely continue to drive that. It's no more a nice to have, but a necessity to have a very clear strategy how you deal with optionality and risk in the markets.
- [42:43]
Paul Chapman
Yeah, which is fascinating really because if we would have this conversation a decade ago, the common refrain would be our investors don't understand trading, they don't want it. They Want exposure to the underlying commodity. That itself is changing partly, you know, how markets are shaped now and sort of the, the activities of very large activist investors that do understand trading have started to change that narrative. But it's just interesting that actually that is going to be. That is already a profound change underway. I want to talk about.
- [43:13]
Roland Rechtsteiner
Sorry if I interrupt you quickly on this point. I just want to quickly get on this because I think it's really interesting the point you mentioned, because that is something I fully agree. That has fundamentally changed over the last five years and today, whilst investors might not necessarily fully understand what trading does and how it works, what they see is actually the bankability of the returns. Yes, there is some volatility year on year in terms of what's the trading profits. And sometimes you have obviously quarterly mismatches of physical and financial which drives some volatility in earnings. But what certainly is there is they see, year on year they see a profit contribution from trading which is bankable and sustainable. And that in itself is driving increasingly the requirement also towards the organizations to deliver this excess profit beyond their pure production activities.
- [44:10]
Paul Chapman
Fascinating. And you know as well, the more you understand, the more you realize that you're going to be better able to value assets, compete for those assets. All profound cascading effects. I want to go back to this idea of a JV in our last, in the last bit of time available. How do you, you know, that is fascinating. It is, you know, to me it's a consequence of. It's very much of a talent story. And obviously we spend a lot of our time at HC helping these NOCs and IOCs and strategics think about plan for through our Talent Intelligence Group and enco, but also obviously build these teams and we're very focused on what is your message, what is your right to win that we can convey to that potential candidate population because it is a fierce competition. If you can't do that, you go and do a jv. But how do those JVS work? Is that. Are we. Will it have. Is it revenue sharing? Is it. Hey, you, you can't, you can't get that 4% uplift because you can't build the trading capability. But hey, we can give you 2% of it. You know, like how, how will that actually mechanically work? And what have we seen with the ones that have been done to date?
- [45:13]
Roland Rechtsteiner
Let's start with why. What do you expect from a jv? I mean, both parties. So if you are the, let's say hydrocarbon producer or refiner that wants to Build a trading capability, what the trading jv, what the trading partner can bring to you. And we've seen a few over the last years happening, a few currently happening. And I think the key driver here or there's a few key drivers. Number one is that you get access to the capability immediately and therefore have a much faster buildup. Number two is that you get access to resources, be that systems, processes, people, as well as other capabilities that are required to actually build the trading activity, maybe even including capital. And the third part, which is not to underestimate, is the DNA and the culture that you can bring. Because the hardest for most of the organizations that are not trading today is to have the conversation internally as well as with their boards on what it means to trade and to also explain that trading ultimately is a lot of logistics, is a lot of risk management, it's a lot of optimization and it's not purely speculative position taken because that's a very small part of the activity if not. And I think that cultural change element is not to underestimate. So that's the reason why people would look for joint ventures with traders. Now what's in for the traders? For the traders it is basically monetizing their capability in a different new entity as well as getting access to certain markets, regions, flows, etc. Even if they are not directly connected to their own portfolio. Because obviously these organizations become trading organization on its own and compete with other trading organizations as well as with obviously the, the trader, the merchant trader, original business. But they actually through that access they can massively participate in these growing profit pools by bringing their capability, their talent as well as sub capital.
- [47:34]
Paul Chapman
I think for the trading houses it's an obvious win, right? It's a one plus one equals three scenario. But for that producer, I guess I'm trying to zero in on kind of how you would see these being structured for the most part. Would it be a revenue share, would it just be a royal. How would that work? Because there's a lot of trust required there.
- [47:57]
Roland Rechtsteiner
I guess, you know, there's different ways of how you can set these up. But I would say the core archetype of how you set up these joint ventures is basically you're creating a new company. You're creating a new company which is, you know, partially owned by the different parties. And that new company is jointly built up and then basically is the trading arm of the producer or the downstream company that's the partner in that at that company is a completely separated business from what you would have, what you would have had before as a trader. And I think that's the important piece because the moment where you, the moment where you for instance, have a joint book approach or where you have you, where you optimize the flows of some of some other organization, it becomes much harder to avoid any kind of value leakage, etc. So, so ultimately, and ultimately what's, what's there for the, the producer is they built their trading business, obviously they have a joint venture partner. At one point in time they might buy out the partner, therefore they give up, theoretically they give up upside during that period of time. But what most of our analysis show is that in most cases the speed of building up the capability is actually supporting the joint venture as opposed to the organic build out.
- [49:22]
Paul Chapman
Let me, let me ask this last question carefully. Do you think in 10 years time that you could predict with a relative amount of certainty who those participants are? Or another way of saying this is, will it be the same cast of characters or is there still scope, do you think, for the rise of another trading house as yet unbuilt?
- [49:46]
Roland Rechtsteiner
It's an interesting question. I think we were always surprised again who suddenly shows up in this market and is actually very successful through different approaches. You know, again, think about the data driven traders, think about the hedge funds suddenly in the market again. So you could always imagine there's new players. But I think certainly what's happening is when you look at some of the new entrants that come with very significant flows or assets, you know, like some of the NOCs, I mean they were building in very few years, very significant positions. And we could certainly see more of that happening. The entry barriers are getting bigger and bigger into this business and you need to have a clear edge which again has to come either through flow capital or sophistication. But I could certainly see a world where there is new players coming in on each of the three elements. Depending on how you want to get into. You know, it could be, you could imagine, as I said on the flow side, obviously new large mining companies or new national resource companies entering the space. You could certainly see from a capital perspective, you could see some private equity or hedge funds building through consolidation, acquisitions, et cetera, new capabilities. And you could see technology players entering the market, which is something we expected for quite some time. And it's certainly still absolutely a very clear opportunity to see that happen.
- [51:13]
Paul Chapman
Yeah, we haven't quite seen that though, have we? I mean it's sort of, yeah, we take us back five years. You know, I was certainly sat there Thinking that there was a number of technology companies we can all name that had every right to start thinking about participating in this market. But haven't. One final question there is the bit, the element that seems to be sort of left out to some extent is on the, the consumer company side, the OEMs or whatever it might be, you know, they also have assets in a different form in terms of, you know, distribution, et cetera, et cetera. They have capital, they have, they certainly have sophistication. Do they have a right to participate here? Do you think they will? Are they similarly on a journey as, as we talk about the producers are?
- [51:54]
Roland Rechtsteiner
I definitely think so. And you can see this already today, Paul, when you think about the large buyers of, of commodities, they all have in some shape or form trading operations. You know, some in a way that they have very sophisticated tendering procurement processes where they are very, very well placed in terms of price discovery as well as pricing and structuring their contracts. And you have others that have built whole trading operations around their shorts. Having said that, you know, in a lot of the commodities, I mean specifically in hydrocarbons, I mean we certainly see the value of shorts, shorts becoming huge in the future and therefore all players that do have shorts which are significant have all rights to participate in this market.
- [52:39]
Paul Chapman
But you better get cracking now and call you and, and call me to continue the discussion. But. Well, Roland, fascinating found. You know, I think it's, you know, there's, there's so much more in this conversation to be had and I look forward to having it with you over future breakfasts and so forth. But once again, thanks for your time and you know, we'll put links to you in, in the show notes and look forward to having you back on, hopefully with not such a big gap between episodes so we can continue the discussion.
- [53:10]
Roland Rechtsteiner
Thank you very much, Paul. I enjoyed the discussion a lot.
- [53:15]
Paul Chapman
Thank you for listening. To find out more about HC Group, our global offices and our expertise in search within the commodities sector, please visit www.hcgroup. Com.