Lessons from the Olam experience

IF there is one lesson to be learnt from the costly and highly public fight between Singapore-listed Olam International and global short selling specialist Muddy Waters, it is the need for commodities players to be much more transparent with the market.

Much ink has been spilt recounting the bruising battle between the company and Muddy Waters, and there is no need to retrace every twist and turn here. Suffice to say that Olam learnt - the hard way, it must be said - that a clearer communication framework with stakeholders is essential for winning the confidence of public capital markets, and the company has now placed that as one of its top priorities in its new strategy.

Besides simplifying the way it presents its quarterly results, Olam has promised to add new performance metrics for investors to track operating cash flow and return on invested capital. It will also release information on which of its investments are performing up to the mark and which are not.

The lesson from Olam's experience is one that would also benefit other commodity firms listed here.

Noble Group and Wilmar International, together with Olam, ranked among the worst-performing members of the benchmark Straits Times Index last year, and continue to languish.

Their share prices are trading at three-year lows despite a bull run in equity markets in the past few months.

While investors here are generally familiar with the sector, the Muddy Waters episode showed that many still may not fully understand the inner workings of commodity houses.

It does not help, too, that the global commodity trading industry has traditionally been an opaque and private one, and the business more opportunistic by nature.

The commodity firms listed here are also admittedly different. Take, for example, the largest ones: Noble has businesses across both hard and soft commodities; Olam is involved in multiple products in the agricommodities complex; while Wilmar has a large manufacturing and processing presence.

But their commonality lies in the complex nature of their operations and the increasingly challenging marketplace.

End to supercycle

In fact, many market observers see an end to the decade-long commodity supercycle, a time when prices of commodities rose and rose, boosted by the voracious appetite of an ascendant China.

In recent years, prices for commodities ranging from sugar to iron ore have seen unprecedented volatility. These have been of such extremes that Greg Page, chief executive of Cargill - one of the largest commodity firms in the world - described it as turbulence.

At the FT Global Commodities Summit in Switzerland in April, he said: "I recently asked one of our trading leaders the difference between volatility and turbulence. His response? 'Volatility can make you money. Turbulence can make you air-sick!'"

Many trading houses have had their previously- smooth trajectory disrupted by such wild price swings. For example, in 2011 Noble Group incurred its first quarterly loss in more than a decade when extreme see-sawing in cotton prices led to widespread counterparty defaults.

Economists and industry observers now expect prices of some commodities to either reach a plateau or start sliding downwards, a scenario described as "backwardation" in the industry where future prices are lower than current spot prices.

Both scenarios don't bode well for commodity traders. They thrive when prices are volatile, as Mr Page suggested in his speech, and in "contango" situations where future prices are higher than current ones, as this allows traders to buy cheap, store the goods, and sell later at higher prices.

Add to this global economic uncertainty, a more connected world where price dislocations are quickly arbitraged and pullback of investors from the sector, and the overall environment for commodity houses seems a lot more gloomy.

It is against such a bleak backdrop that the clarion call for greater transparency in the industry is being sounded.

In an interview with The Business Times earlier, HSBC global head of commodity and structured trade finance Jean-Francois Lambert said that if commodity trading houses do not become more transparent going forward, they risk losing support from their banks and customers.

More transparency

The public and regulators are already clamouring for more transparency and proper governance in banks after the global financial crisis. This pressure will in turn filter down to trading houses as banks become stricter in their lending decisions. So the more transparent a corporate is, the more organised, the more proper and structured its governance is, the better it will deal with the financial system, said Mr Lambert.

His comments follow an earlier call by Cargill to the industry to adopt responsible practices and "behave appropriately, properly and ethically".

"We can either earn and embrace the governance and regulation we want and need, or ignore our ethical, behavioural and societal obligations, and then accept the governance that others may impose upon us."

Indeed, the world is becoming a tougher one for commodity firms. And the best way to navigate the increasingly challenging operating environment is via greater transparency, whether in terms of better corporate governance, more ethical practices, or clearer communication of the issues that a firm faces and its strategies.

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