Managing complexity
Agility, teamwork and IT provide the platform for growth.
To manage complex supply chains and move commodities around the world requires many things including infrastructure, risk management, sophisticated IT systems, and a skilled workforce, with a clear governance framework. These pillars and other important elements – such as our employee ownership model – have been the foundations of our company’s success since its inception in 1993.
Over the past three years, our systems, people and processes have been tested as never before in a persistently and increasingly volatile business environment; first by the global pandemic and more recently Russia’s invasion of Ukraine.
Risk management process
Trafigura is an active participant in commodity derivative markets. We use futures contracts to manage price risk and lock in profit margins when we are moving commodities from where they are produced to where they are consumed. The reason we do this is because supply chain management is fundamentally a low-margin business, operating in markets where prices are often subject to very significant changes outside our control.
In the exceptionally volatile market conditions of February, March and April this year, access to these markets became more difficult and expensive. This was because exchanges and clearing brokers significantly increased margins – or cash deposits – required for each transaction. This sometimes happened at very short notice.
As a result of these margin calls and fearful of a cash drain, some users backed away from the market and liquidity dried up.
For a company the size and scale of Trafigura, this lack of depth in financial markets presented a number of challenges, which we were swift to address.
First, we moved quickly to secure USD2.3 billion of additional liquidity from a number of our core lenders to provide a cash buffer. In addition, we also reduced our trading volumes, focusing on higher margin business.
In some particularly volatile or illiquid parts of the markets, as part of a prudent approach to risk management, derivative positions on future exchanges were supplemented with alternative risk mitigation measures. Assessing and managing the liquidity risks and costs associated with hedging on futures markets has become a core part of a trader’s job.
As a company, we are focusing on how we use and access futures markets in a more volatile and uncertain world, assessing the alternatives and not simply defaulting to past practices. And that perhaps is the biggest learning of the past year – a greater awareness of what can happen in financial markets and the impact that can have on our day-to-day business.
Although liquidity on exchanges has improved, it has not returned to its pre-pandemic levels. Certain parts of the market remain difficult to access and that means that some hedges will not continue to perfectly offset the price risk associated with an underlying physical cargo. In these instances that leaves us with a choice: we can either turn away business or charge a higher margin to compensate.
Overall, our risk exposure – as measured by average Value at Risk (one-day 95 percent) – increased during the year because of the extreme market volatility that followed the start of the war in Ukraine. However, in the final quarter of our financial year, average VaR decreased and was less than one percent of Group equity, due partly to the actions previously outlined.
Compliance
Clear communication and teamwork were also vital in addressing government and regulatory interventions following the invasion of Ukraine.
While sanctions have been a feature of commodity markets for many decades, an unprecedented number of transactions were affected by the sanctions imposed on Russia. Since March, there have been eight iterations of EU sanctions with the prospect of more to come, plus the associated introduction of the G7 price cap on Russian oil.
Keeping pace with the introduction of new rules across a number of jurisdictions was the job of our strong global compliance team which worked closely with senior management and our commercial teams to understand what was prohibited by sanctions.
Commercial teams' access to compliance and vice versa was exceptional during the year, underscoring the importance of Trafigura’s open-door policy and team ethos where all parts of the business pull together to support each other.
Our Compliance team had access to the right people internally and externally to dissect the information as it came in and to disseminate it very quickly. As one of the world’s biggest supply chain managers, we must be compliant with sanctions and regulations.
Costs and inflation
Although 2022 has been an exceptional year for our company, we have not been immune from the inflationary pressures affecting other industries and the major economies of the world. As such, it is important that we do not become complacent with regards to our cost base.
To that end, we maintained a laser-like focus on our overheads. Puma Energy provides one example of how we approach this challenge. Since the consolidation of the company into the Trafigura Group a year ago, its management team has worked hard to rationalise its cost base and reduce unnecessary wastage. This has injected a lot of positive momentum into the business.
In the year ahead, we will seek to become even more efficient in our processes, utilising technology and Titan, the proprietary software platform that we use to manage and plan our business activities.
Data science and engineering
In total, Trafigura spends around USD200 million per year on information technology across a number of platforms including Titan. One focus of activity has been data science – the systematic analysis of data within a scientific framework.
Due to advances in digital technology, there is now a vast amount of publicly available data that can at times be overwhelming. But if it can be analysed and structured correctly this data can be highly valuable and provide the company with a competitive edge.
This applies not only to our traditional markets where traffic and aviation data, for example, can help predict peaks and troughs in oil demand, but also to new ones such as gas and power trading, where prices move in response to a complex number of factors that only a computer can process and understand.
Bringing together a huge number of databases and feeds and writing software to integrate the data into machine learning models is no easy task however, and it requires continued investment in our Data Science and Engineering team. We are working to make our data science platform more accessible so that it is easy for employees to access around the world.
Employee shareholder model
Finally, a comment on Trafigura’s corporate employee ownership model. Since the company’s foundation almost 30 years ago, it has been owned by a growing number of its employees, for whom equity is an important element of remuneration. 2022 saw a further increase in the number of shareholders, which now stands at more than 1,100.
We continue to see significant benefits from our employee shareholder model. Not only does it set the company apart from our peer group, it also offers a powerful retention and recruitment tool. This is important as the company expands into markets such as green hydrogen and power trading that require a different set of skills to those typically associated with our industry.
Our shareholder model encourages our senior employees to take the long view and think hard about risk, business continuity, and the future performance of the company.
Above all, our shareholder structure drives a close alignment between management and senior employees, leading to a highly transparent and collaborative culture that we believe is unique in our industry.
Mike Wainwright
Executive Director and Chief Operating Officer
