The oil price war - winners and losers

[David Guyatt]

From Fortune via Academia.edu:

he unseen hand that moves the world's oil
By Brian O'Keefe with Doris Burke
@FortuneMagazine
February 28, 2013: 9:08 AM ET
Vitol built this state-of-the-art storage terminal in Cape Canaveral, Fla. Open since 2010, it supplies the nearby port, the Orlando airport, and gas stations across centralFlorida.
(Fortune)
The man who runs the biggest, most important company you've never heard of bounds into the room with a grin. In hiselegant navy suit, and with his cheerfully self-effacing personality, Ian Taylor is the very model of a British executive. The57-year-old is bald on top and graying on the sides, yet he sparkles with boyish enthusiasm. It almost goes without sayingthat he's eloquent, having studied politics, philosophy, and economics at Oxford. His firm is just one player in a "whackinggreat" industry, he explains. But he's happy to discuss his business. Simply put: He buys oil in one place and sells it inanother, hoping to make a profit. In reality, it's a bit more complicated than that.Taylor is CEO of the Vitol Group, the world's largest independent oil trader. According to results provided by the company,Vitol, which is a private partnership, racked up revenues of $303 billion in 2012. That would make Vitol the biggest privatecompany in the world by sales, ahead of commodities industry peers such as Cargill and Koch Industries. If Vitol werepublicly traded, its reported revenues would have ranked it No. 7 on last year's
Fortune
Global 500, ahead of Chevron andToyota. Margins in the trading business are razor thin, but the company's profits are divvied up among just 350 or soshareholders.Despite those jaw-dropping numbers, Vitol is a mystery even to many in the oil business. Dan Yergin, the chairman of IHSCambridge Energy Research Associates and the foremost chronicler of the oil industry's rise in his books
The Prize
and
The Quest
, says that while he knows Vitol's name, "I must admit that I don't know too much about them."How vital is Vitol? Think of the company as an unseen hand that helps steer global energy markets. The company isprimarily engaged in the physical trading of oil -- moving it from places of surplus to areas of deficit. That means that Taylor and his associates do a lot more than use derivatives to make bets on the future direction of crude prices. The companybuys and sells more than 5 million actual barrels of oil each day. "Our basic function, I suppose, is being an incrediblyimportant connecting pin to making sure that oil is delivered to where it's required," says Taylor.That takes remarkable logistics capability. Last year Vitol chartered more than 5,400 ship voyages. At any one time, it hasabout 200 tankers on the seas hauling cargoes worth tens of millions of dollars -- ships that are potentially vulnerable toeverything from pirates to typhoons to more mundane, but still costly, mechanical or weather delays.Vitol is the largest of a group of trading companies that fill in the gaps between the big oil companies, such as Shell andExxon, state-controlled producers, and hundreds of smaller players around the world. This trade has grown over the pastfew decades as the original, integrated system has broken down. "Once upon a time oil flowed from the wellhead all theway to the gasoline pump within a single corporation," says Yergin. "That began to change after the first oil crisis in the1970s." Consider that today Vitol sells gasoline to Saudi Arabia and supplies crude to Exxon for refining.









The volume of energy Vitol trades -- in addition to crude oil, it buys and sells everything from gasoline to natural gas to jetfuel to coal -- has more than doubled in less than a decade. (The company also happens to trade about 5% of the world'ssugar supply.) Rising energy prices have driven even faster growth in revenues. In 1995, the year that Taylor took over asCEO, Vitol had revenues of around $13 billion. Ten years ago it was still less than $50 billion. Since then it's exploded.Vitol's highest-profile rival in this great game is Glencore, the Swiss commodity trader formed by former partners of MarcRich, which went public two years ago and ranks No. 14 on the Global 500 list. In its most recent fiscal year, Glencorereported $115 billion in energy trading, but it is better known for its heft in the metals markets. Other privately heldcompetitors -- such as Gunvor, Mercuria, and Trafigura -- more closely mirror Vitol's focus on energy trading, but nonematch its scale.To get their hands on new product, Taylor and his traders compete with their rivals for the favor of government officials andexecutives in former Soviet republics, Arab kingdoms, and unstable African countries. Taylor oversees the far-flungoperation from the company's London office, across the street from Victoria Station. The company has offices in 30countries, including major regional centers in cities like Houston, Moscow, Dubai, and Singapore.Because of Vitol's size and its confidence in its own ability to manage risk, the company is often willing to deal withcustomers that more conservative companies shun. Vitol, for instance, has done business over the past couple of yearswith customers in Greece, Egypt, and Yemen, despite serious credit issues in those nations. When the rebels in Libya weredesperate for gasoline and diesel, Vitol, urged on by several governments, was for a time the only trader willing to risksupplying them.Not surprisingly, Vitol's dealings have sometimes drawn criticism. Notably, in 2005 it was one of many companies identifiedin an independent investigation led by Paul Volcker as having paid "surcharges" to the regime of Saddam Hussein to buy oilthrough the United Nations' "oil for food" program. As part of the fallout, in 2007 Vitol pleaded guilty to grand larceny, afelony, in New York County Supreme Court and paid $13 million in restitution and a $4.5 million fine.More recently some U.S. lawmakers have raised questions about Vitol's trading with Iran and whether Vitol should beallowed to buy oil from the U.S. Strategic Petroleum Reserve. The U.S. and the European Union have imposed tradesanctions on Iran, and Vitol says it has fully complied since President Obama issued an executive order authorizingadditional sanctions on July 31, 2012. But last September, Reuters reported that Vitol had bought fuel oil from Iran. Taylor says it was a single cargo that a Vitol trader in Asia agreed to buy weeks earlier. Vitol, he adds, won't trade with Iran as longas sanctions apply. "Not another drop," he says.Taylor says there is an inherent tension built into the company's role as a global connector of dots. "Because we're going totrade everywhere around the world, we will occasionally be trading in countries where people feel maybe we shouldn't be,"he says. "Now, okay, we do have our own internal moral sort of values that we do occasionally apply to this. But in general,we feel it's the right thing to do, which is to carry on participating in most countries, providing there are no sanctions, inwhich case we immediately will abide by them, obviously. Or providing there's not a situation which we feel is bluntly notacceptable, according to our values."In recent years Vitol has begun to acquire or develop physical assets -- refineries, terminal facilities, pipelines -- around theworld, including in the U.S. Taylor sees these investments as a way to boost his business in an increasingly competitivetrading market. Though Vitol's sales for 2012 were up marginally over 2011, its oil-trading volumes were down. "There arenot huge, great pockets of freely traded oil that we can unquestionably still add on," says Taylor. "We fight very hard to dothat, but there's not great chunks, really."Vitol's move into owning assets is also part of a larger story in the oil industry. The major oil companies continue to try toshed low-margin "downstream" businesses to focus on higher-margin upstream exploration projects. And Vitol and itstrading peers are snapping up many of those properties to give them added flexibility -- a concept they call "optionality."What it means is that Vitol and its peers are likely to have an even more important role in energy markets. To understandVitol is to gain insight on how the gasoline really gets in your tank and on how the world of big oil is evolving.One day last spring a Vitol trader in Geneva agreed to buy a cargo of 720,000 barrels of "Urals" crude oil from a seller inRussia. As part of the deal, the Vitol trader would send a tanker to Russia to collect the oil, worth roughly $80 million, inearly May. The two parties agreed that the price of the cargo would be finalized based on the average price of Brent crude,the most common benchmark for crude oil in Europe, over the entire month of May. A Vitol trader is like a quarterback of a well-coached team. As soon as a trader agrees to a deal, he kicks off a chain of activity from the rest of the squad. Contracts must be sent out. Inspectors must be appointed to make sure the oil is loadedproperly. A letter of credit must be obtained from a bank to guarantee payment. A ship must be chartered and vetted. Andevery aspect must be monitored because the details can make or break the profitability of a deal. Often the margin maydepend on managing freight costs. Each purchase or sale must be hedged to limit risk.







Shortly after buying the Urals crude, the Vitol trader agreed to sell it to a buyer in the Caribbean and deliver it a few weeksafter picking it up in Russia. The sale price would be determined by a formula based on the average price of WTI crude for a five-day period in May. WTI is the most common benchmark for North American crude prices. At the time of the deal, itwas trading for about $15 less than Brent.The fact that the trader bought the oil priced in Brent and sold it priced in WTI added an extra layer of complexity to thehedging. For each of the 23 trading days in May, Vitol had to sell futures against the Brent price to hedge its purchase price. And it had to buy futures against the WTI price for the five pricing days to hedge the sale price. During the course of May,the price of oil plummeted -- Brent prices dropped from $120 to $103 a barrel -- adding to the trickiness of the hedging.The headquarters of Vitol's trading business is located in downtown Geneva, on two floors of an eight-story building abovea nightclub. The traders and their assistants sit in clusters of desks in an open space taking up just over half a floor. On themorning I visited, there was a muted buzz as the traders pondered a sharp drop in the price of Brent crude the day before."What does a trader do?" says David Fransen, a tall, thin, bespectacled Brit who heads up Vitol's trading unit. "He's not justthinking, 'Oh, I believe oil is going to go up, so I'm going to buy some.' It's more like, 'I'm going to buy something here, andI'm going to hedge it there. And what are my costs? How's my P&L? How was my hedging yesterday? So, the market wentup. I thought I was hedged. Did I make or lose any money? I'm long Europe vs. New York -- did my spreads go the rightway? Do I need to change it?' That's what the traders do. Decide on how to react."The margins in physical trading are thin -- a profit of 1% or less is typical. Of course, a small margin on a giant grossrevenue number can still create big profits. In 2010, for instance, Vitol had $206 billion in revenue and $1.5 billion in netincome, according to figures from Thomson Reuters. That's a margin of just 0.7%. A better year was 2006, when Vitol got aboost from selling a refinery and earned $2.2 billion in profit on $116 billion in revenue, for a margin of 1.9%, according tofigures from Dun & Bradstreet.Still, it's a lot of work to earn a buck. "It does beg the question of why on earth we play around with something so complex,"says Fransen. "Because the more we talk about it, the more it seems like it would be an awful lot easier just to buy futuresand sell futures. But that's far too risky for us. This is where our skill is."The company has been developing its skill set since it was founded in Rotterdam in 1966 by a pair of Dutchmen, HenkVietor and Jacques Detiger, who traded barges of petroleum products up and down the Rhine. (They came up with "Vitol"by combining Vietor's last name with "oil.") A couple of years later, they opened the office in Geneva, which was becoming ahub of commodities trading. Taylor remembers them as courtly gentlemen who liked to play dominoes.Taylor joined the company as a trader in 1985 from Shell, where he had been learning the craft of trading oil. In part tomove their production and supply their refineries, Shell and BP run trading operations that are even larger than Vitol's andthat have long served as training grounds for Vitol and the other trading houses. After nearly 30 years at Vitol, Taylor has accumulated more than enough wealth to retire and live the easy life. Married, withfour children ranging in age from 11 to 24, he sits on the board of the Royal Opera House. Six years ago he swooped in asan angel investor to help save the Harris Tweed industry on the Outer Hebrides islands at the behest of his friend BrianWilson, a former British trade and energy minister who lives there. But get him talking about the details of his tradingbusiness, and it's clear that he's deeply engaged.The CEO describes Vitol's approach to risk management as "relatively informal," in the sense that there isn't a dedicatedrisk-assessment group. But because the company is a partnership, everyone is engaged in scrutinizing and evaluating riskat all times. "A lot of people are involved in every change of direction that we make," says Taylor. Every trade can betracked through a proprietary trading and operations system that Vitol designed in the late 1990s. Twice a day it generatesrisk reports that the traders can use to, say, assess exposure to certain counterparties or to a particular country.Vitol's risk tolerance was put to the test in 2011 when Taylor received a call from the Qatari government asking Vitol tosupply the rebels fighting Muammar Gaddafi with gasoline and diesel in exchange for crude from rebel-controlled oilfields ineastern Libya. Urged on by a coalition of governments, including the U.S. and Britain, Vitol took a calculated risk bysupplying the rebels, and continuing to supply them even when payment was slow in coming. Eventually Vitol was fully paidwith oil from the rebels as well as funds released by the UN. "It was a bit hairy," says Taylor. "There were one or twosleepless nights, I can assure you."Not every trade is a winner. The trader who bought the cargo of Urals crude in Russia sold it in the Caribbean and ended uplosing $5 million on the physical trade. With hedging, the deal turned a profit of $5,430. To make the trade happen, Vitol hadto produce 391 regulatory filings. It sounds as if it was hardly worth the trouble. But we don't know how it played into thetrader's overall strategy. He might have sold the cargo in the Caribbean so that there would be less Urals crude available inEurope, which might have boosted the value of another cargo and netted a big profit.