The worst of the liquidity squeeze on eurozone banks has eased conditions for commodities finance during 2012, but the business still faces significant challenges.

Repeated market and verbal interventions by the European Central Bank in late 2011 and throughout 2012 have gradually prised open the vice that threatened to squeeze eurozone bank funding. Banks from France, Germany and Netherlands in particular have historically been the core providers of both short-term commodity trade finance, and long-term project finance for commodity exploration and production, and power generation.

Federico Turegano, global head of natural resources and energy at Société Générale Corporate & Investment Bank says the pool of top project finance advisory banks remains largely unchanged, as it takes time to build such a franchise. But the process of syndicating large loans (of about $1bn or more) for working capital or individual projects has changed significantly.

“In the second half of 2011, you really had to work hard to know which banks would come in on any given deal. Today, we have a better view of which banks are going to be there or not and, while the European liquidity issues in the second half of 2011 have substantially subsided, they opened the eyes of US and Asian banks to a business that is mostly conducted in dollars,” says Mr Turegano. Citi announced the launch of a commodities finance division in September 2012, and David Wigan discusses in this report the growing participation of emerging-market banks. Mr Turegano says every syndicate arranger now has to take the role of Chinese banks in particular very seriously.

“Chinese banks were not really involved in commodities or project finance five years ago, whereas today they can change the nature of a deal, and that is probably the biggest single change in the market in recent years,” he says.

Changing formats

Among European banks, one of the few looking to grow its commodities finance business significantly is ABN Amro, rescued by the Dutch government in 2008 from the wreckage of the Fortis takeover. The bank’s energy, commodities and transportation (ECT) division already has overseas offices in New York and Dallas, and Harris Antoniou, ABN’s head of ECT, says the purchase of Brazilian Banco CR2 in October 2012 should also give his team access to a fast-growing consumer and large producer of agricultural, mineral and hydrocarbon resources. However, he notes that even those banks still providing commodities finance have changed their approach to the market.

“Syndicate members tend to be more active in the secondary market, willing to sell down more of their relationship client exposures. And tenors are shorter, with facilities of three years or longer becoming noticeably more expensive,” says Mr Antoniou.

Commodities and project finance have always been largely secured lending, and that format has become even more dominant as banks move early to manage risk-weighted assets under Basel III rules. Other structural changes are also apparent.

“Pre-crisis, around 60% to 65% of finance was in funded credit lines, mostly for inventory finance. Today, that proportion has fallen to around 50%, with the rest comprised of unfunded formats such as letters of credit or guarantees,” says Philippe de Gentile, head of energy and commodity finance at BNP Paribas.

However, he adds that this switch to unfunded formats has not been too painful for the industry so far, as market participants only want to store inventory when the shape of the price curve is in contango – with forward deliveries priced higher than the spot market. That has not been the case for most commodities since mid-2011.

Winners and losers

Expectations of a slowing economy in China, the marginal buyer for many commodities, are the major reason why many commodity curves, especially for metals, are backwardated, with prices expected to fall going forward. The London Metal Exchange is estimating a large global steel excess, with prices falling below costs for some producers. And new mining projects need seven- to 15-year funding in dollars, which is still difficult for many European banks.

“We have seen some delays in coming to the market on more frontier mining projects in Mongolia and parts of Africa, but we still believe that those projects will go ahead,” says Mr Turegano.

Mr de Gentile says BNP Paribas is still keen to be involved with smaller projects undertaken by independent producers, but the pipeline is not vast. Iron ore and coal miners are sometimes struggling to develop profitable new mines, whereas gold mines are more successful.

“Many producers do not want to hedge the commodity price in their financing transactions, as they want to offer commodity price exposure to investors, but we have to be careful of our own lending criteria,” says Mr de Gentile.

The two areas generally regarded as most attractive are natural gas – and especially shale gas – plus renewables. Mexico, China and Mozambique are all thought to have shale gas reserves on a scale that could rival Qatar, the world’s largest producer of conventional natural gas. As Edward Russell-Walling discusses in this report, there are questions over government support for renewables, but Mr Turegano says these projects can work well in partnership with conventional energy.

“Renewable sources such as wind and solar face issues of intermittency of supply, so they need conventional thermal power stations co-located. Of the hydrocarbons, natural gas offers the best alternative in terms of emissions,” says Mr Turegano.


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