COMMODITY TRADING

GOES BACK TO THE FUTURE

AS TRADING MARGINS CONTINUE TO DECLINE, PROPRIETARY INTELLIGENCE
IS ONCE AGAIN DETERMINING WHICH TRADERS WILL THRIVE
The combination of unprecedented political uncertainty, trade wars, and rapidly evolving
technologies is making commodity markets almost as unpredictable as they were during
the financial crisis. But the chances of repeating the industry’s most profitable year to date
are remote.

Black and grey swan events will continue to result in intermittent spikes in volatility.
But these will only provide temporary relief from the relentless erosion in trading margins
that started in 2014. In fact, we estimate margins could likely decline by at least another
15 percent over the next five years as commodity markets become more stable and more
transparent and competition becomes more intense. (See Exhibit 1.)

This cutthroat environment will weed out the players that continue to follow the tactics
of the past from those pioneering new trading strategies by investing in advanced
predictive analytics to develop proprietary digital intelligence. As the amount of new
digital data available continues to soar, the top players will return to their roots and rely
more on developing information advantages from which they can increase their profits.
The traders who develop the operating model to support these analytics will succeed
and grow, while smaller players that can’t afford to invest in new digital capabilities will be
forced to retrench.

Exhibit 1: Shrinking Commodity Trading Margins

Commodity trading margins are collapsing, putting even more pressure on players to reach scale
COMMODITY TRADING GROSS MARGIN GLOBAL TITAN CONTRIBUTION
USD BN, 2007–2025F %

70 70%
67% CHANGES
2017/2018
60 60%
55 57 Top 10 share 57% Others1
50 50%
44 44 44 Softs
40 39 41 >1/3 40%
38 38
35 36 35
Metals and mining (inc. coal)
30 <30 30%

Power and gas (inc. LNG)

20 20%

10 10% Oil (crude and products)

0 0% Total
2007 2008 2009 2010 2011 2012 2012 2014 2015 2016 2017 2018E 2025F

1. Others include Asia power and gas, emission, exotics, and investor products
Source: Oliver Wyman proprietary data and analysis

Copyright © 2019 Oliver Wyman 1

COMMODITY TRADING
MARGIN MELTDOWN
Signs of the coming dramatic shakeout that will result from the commodity trading margin
squeeze are already at hand. Trading margins have fallen by more than 20 percent from their
recent peak in 2015.

This trading margin meltdown will continue as commodity markets become more mature,
stable, and liquid. Over the past decade, the volume of commodity contracts traded
nearly tripled and the value of contracts traded on standard electronic platforms doubled.
Commodity market data is also increasingly readily available and widely socialized, as a
greater number of players sell information and provide services to commodity traders.
These new sources of data allow commodity traders to estimate much more precisely
events that impact their trading strategies, such as when commodities will arrive at a specific
destination and when local stockpiles will be high or low.

The combination of increased transparency and gluts in almost every commodity should
keep volatility in the relatively tight band it has been confined to since 2012. (See Exhibit 2.)

Exhibit 2: Minimal Commodity Price Volatility

Volatility spiked toward the end of 2018 to levels not seen since 2012. But it has remained within a comfortable
10–15 percent band since the end of 2012
PRICE ADJUSTED ANNUAL VOLATILITY1
%, 31/12/2007 PRICES = 1.0
70%
First breach of
60% volatility band set
in 2012, but short Oil Vol
term spike driven by
50% extreme Henry Hub
price movements
4Q 2018. P&G Product
40%

30% Soft Product

20% +/-5%
M&M Product
10%

0% Ave Product
31/12/07

31/12/08

31/12/09

31/12/10

31/12/11

31/12/12

31/12/13

31/12/14

31/12/16

31/12/17

31/12/18

1. Average includes Brent, WTI, ICE Gasoil, EU Power, NYMEX HH, ICE NBP, CBOT Wheat, CBOT soybeans, ICE Cotton, LME Cu, LME Ni, LME Al, COMEX Au, NYMEX Pt,
NYMEX Pd. Average rolling 30 day volatility, 60 rolling average. Prices relative to 31/12/2007
Source: Reuters, Oliver Wyman analysis

Copyright © 2019 Oliver Wyman 2

This means margin will continue to be taken away from traders. Major commodity producers
and consumers like national oil companies and miners will charge higher premiums
and claim more margin as they expand their global reach and become more sophisticated
market participants. Simultaneously, physical infrastructure service providers and new
online platforms will impinge on traders’ traditional roles. These players are making traders
less essential by removing bottlenecks in order to correct supply imbalances and connecting
more commodity producers and consumers directly.

So traders are forced to do more and more to gain an edge by further increasing their
scale. Top players are snapping up multi-billion-dollar commodity assets to protect their
positions by bulking up their massive trading portfolios. Medium-sized traders are shutting
down non-core businesses. Many small traders are pulling out of the commodity trading
business entirely.

Copyright © 2019 Oliver Wyman 3

PROPRIETARY
DIGITAL INTELLIGENCE
The most important driver of the shakeout of the industry is trading giants’ investments
in predictive analytics which provide them with significant information advantages.

Large commodity traders once again consider proprietary intelligence critical.

When commodity trading firms as we recognize them today were first established in the
1970s and 1980s, top traders relied primarily on privileged information to outperform their
peers. More recently, players have tried to gain an edge by focusing on ways that advanced
technologies can improve their efficiency primarily through automation.

Now, commodity traders are going back to the future. Instead of relying on extensive
traditional information networks to gain advantages from proprietary data, traders who
are large enough to invest in the sophisticated systems and dedicated teams required
to compete are focusing on how to use predictive analytics to draw valuable proprietary
insights from common data sources. (See Exhibit 3.)

Exhibit 3: The Rising Importance Of Commodity Trading Proprietary Intelligence

Proprietary market intelligence will become even more important as advanced proprietary analytics improve
ADVANTAGE TO TRADERS FROM PROPRIETARY MARKET INTELLIGENCE
ILLUSTRATIVE

Competitive advantage from

1 proprietary data

Overall differentiation
potential from market
3 intelligence

2 Power of analytical
capabilities

Time
1980 Today 2020+

1 2 3 4
Mass socialization of data Currently at the cusp Ballooning impact from Residual advantage in
over the last 10–15 years of a return of the power the power of analytical niches where still possible
erodes the possibility or of proprietary market capabilities to create to have raw data analysis
proprietary advantage intelligence proprietary analytics

Source: Oliver Wyman analysis

Copyright © 2019 Oliver Wyman 4

Today’s proprietary intelligence is obtained from a combination of more widely available
data sources from sensors, geospatial satellites, and even social media run through advanced
algorithms developed in house by data scientists. These algorithms are run on previously
unimaginable hardware with exponentially greater processing power, to rapidly translate
and interpret the huge volumes of data, enabling traders to formulate unique market views.
Then, the results are monetized across major trader firms’ expansive global trading portfolios.
Large trading volumes are essential to ensure returns from advanced analytics. Without them,
traders cannot generate enough value to cover their development costs.

As commodity markets become more liquid and accessible, commodity traders are relying
more and more on algorithmic trading, coupling predictive analytics with robotic trade
execution. Traders are improving their ability to hedge and speculate by developing
codes that more nimbly identify trades and execute them across a broader set of
tradable instruments.

But this new digital approach to developing proprietary intelligence requires completely
revamping traders’ operating models. Commodity traders need to be willing and able to
experiment in order to be players in the new world of predictive analytics that is evolving.
At a time when trading margins are razor thin, top traders often need to invest millions of
dollars in multiple, large pilot programs to discover two or three viable new trading strategies.
It is often unclear if anticipated relationships between data feeds and commodity prices
actually exist, and even if they do it is not certain the volume of data is sufficient to make
meaningful predictions. For example, it is incredibly difficult to analyze global satellite imagery
to identify precisely the daily flow of commodities given the frequency at which images are
being taken. Depending on the specific market, these signals are often also relatively limited
compared to just market sentiment when forecasting in the horizon of interest.

More broadly, commodity traders need to embrace new ways of working. Developing
top notch predictive analytics often requires setting up data science teams in a way that
means they can operate differently from traditional commodity trading organizations, while
remaining deeply linked. So commodity traders are establishing incubators, entering joint
ventures, and striking partnerships with consultancies and universities. In some cases, they
are even pioneering ways that they can monetize proprietary intelligence outside of their own
trading and sales activities.

Simultaneously, existing teams of traders, quantitative analysts, and developers must work
more nimbly to make the most of short-lived information advantages. Until now, traders
and quantitative analysts have identified key metrics for trading strategies and then asked
developers to provide them with forecasting tools over a period of weeks or months.

Moving forward, rather than spending weeks on transforming spreadsheets into code,
quants and data scientists must concurrently work in code and draw from shared data lakes to
transform valuable insights into pilots and proofs of concepts for trading strategies. To predict
market behavior, they must use predictive analytics techniques ranging from single factor
analyses to more complex techniques such as convolutional neural. And quantitative analysts
need to become more familiar with data science techniques, tools, and ways of working.

Copyright © 2019 Oliver Wyman 5

DIGITAL TALENT GAP
Commodity traders also have to find new ways to attract and keep talent in an increasingly
digital workplace. Commercially-driven quantitative traders have worked in commodity
trading organizations for decades. But to gain a competitive edge, commodity traders
increasingly need data scientists in addition to their usual quant teams to transform much
more complex and varied digital data feeds into trading strategies.

The challenge is that dedicated data scientists are universally in high demand. Generally,
these digital data problem solvers prefer to work for prestigious tech giants and high paying
hedge funds rather than commodity traders. So commodity traders need to recalibrate their
recruiting strategies to attract data scientists primarily by interesting them in pioneering
digital solutions for seemingly impossible complex problems. After that, commodity traders
need to make sure there is a steady flow of such challenges to retain their interest.

Commodity traders must also revamp their organizations so that the expertise of their data
scientists can be spread broadly. For example, commodity traders should set up core teams
of purely data scientists in data labs to tackle their toughest challenges and empower them
to bring in external talent to supplement when necessary. However, this team will not be as
commercially driven as traders and analysts. As a result, in order to transform theoretical
solutions into the practical profits, traders also need a deep “bench” of quants with
commodity trading expertise who are fluent in the language and application of data science
to partner with and be guided by a core team of data scientists.

These data science-infused quants should be deployed to work on developing or monetizing

cutting-edge analytics with the data scientists. Much like banks, law firms, and consultancies
recruit and train generalists, traders will hire quants for their raw capabilities and then assign
them to the task where they display the greatest aptitude. The growing importance of these
generalist quants will require a cultural shift for trading companies who will need to hire
them at an entry level and have their bench become part of the standard rotations of newly
hired college graduates.

Members of the core team of data scientists will also have to be moved through different
parts of the organization so that they can interact with the larger group of existing top
quantitative analysts and traders. They can then mentor others who are just starting out
on what will eventually become a broader shift for the industry from developing analyses
in spreadsheets to working them out in code. Once this happens, analysts with coding
capabilities will be able to abstract and reuse solutions to improve traders’ strategies across
the board or even move themselves into the front office, trading on the back of their models.

Copyright © 2019 Oliver Wyman 6

RETURN TO THE CORE
Only the largest traders can currently invest in predictive analytics because only they have
sufficient scale to monetize results profitably and the capital to invest in sophisticated
systems and dedicated teams. This gives them a significant edge over smaller traders and
will result in even more margin concentrated in major players. Consolidation will accelerate,
at least until the cost of advanced analytics decrease. Top traders will continue to gain
an even larger share of the industry’s profits by taking advantage of predictive analytics,
while forcing other players to focus even more on only their core competitive advantages.
(See Exhibit 4.)

Exhibit 4: The New Commodity Trading Landscape

The return of the importance of proprietary market intelligence will force all commodity traders to adopt
new strategies
SURVIVAL MECHANISM GLOBAL TITANS OTHER PLAYERS

PROPRIETARY INTELLIGENCE • Leverage scale of flows and possibility • Figure out where core competitive advantage
to invest by developing predictive analytics enables proprietary data or understanding

ECONOMIES OF SCALE • Continue the quest for scale • Reduce non-core activities (sacrificing marginal
P&L to enable improved margin)
• Creation of digital operating model to monetize
predictive analytics as best as possible • Pursuit of cost savings through digitization –
block chain across companies and robotic
• Creation of fit for purpose digital talent model process automation of internal processes

Source: Oliver Wyman analysis

To compete, commodity producers, national oil companies, large commodity consumers,

and midsize traders will need to reassess their strengths and invest in them. They will
have to be sure to optimize any advantages they have in terms of their access to assets,
equity flows, proprietary data, niche trading capabilities, or differentiated business models.
Advanced analytics may even enable players with sufficient scale in their niche to strengthen
and defend their position. However, to do so, many may need to enter joint ventures or
partnerships in order to reach a large enough size to be able to monetize their advantage.
At the same time, these traders will have to continue to lower costs and investigate operating
and commercial models that give them an even bigger bang for the buck.

That means midsize players must shed noncore businesses, strike alliances to gain access to
larger portfolios, and automate back office functions. By relying more on robots to conduct
basic tasks such as reconciling data and blockchain to manage intercompany paperwork
exchanges, some commodity traders have lowered their costs by as much as 30 percent.
But it’s clear from the past several years that, like other industries, commodity traders cannot
simply cost cut their way to success.

Copyright © 2019 Oliver Wyman 7

 THE PATH FORWARD

Traders need to make maximizing the potential of information

advantages their top priority. Previously unthinkable digital
capabilities will determine who will be the industry’s leaders
in the long term.

Copyright © 2019 Oliver Wyman 8

Oliver Wyman is a global leader in management consulting that combines deep industry knowledge with specialized expertise in strategy,
operations, risk management, and organization transformation.
For more information please contact the marketing department by email at info-FS@oliverwyman.com or by phone
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AUTHORS

Alexander Franke, Zurich-based partner in Oliver Wyman’s Energy practice

Adam Perkins, London-based principal in Oliver Wyman’s Energy practice
Roland Rechtsteiner, Zurich-based partner in Oliver Wyman’s Energy practice
Graham Sharp, co-founder of Trafigura and a senior advisor to Oliver Wyman

www.oliverwyman.com
Copyright © 2019 Oliver Wyman
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