Glencore results underline opportunity costs

It’s turning out to be a day of ‘hedges’ at Glencore.

The shares have been volatile on Thursday and were up a modest 5.6p as I wrote this, despite the group reporting an 18% rise in core profits (Ebitda) for 2016 of $10.3bn. That looks about 11.6% abouve most City expectations. Like its global mining peers that reported earnings over the last couple of weeks, Glencore’s preliminary full-year report is replete with impressive improvements on costs, efficiencies, productivity and net debt reduction, as well as displaying conspicuously tighter discipline on capital expenditure.

Glencore does however also reveal what it curiously terms an “opportunity cost” in coal that shows more of the latter word than the former. It says a hedge trade to protect the price of 55 million tonnes of future coal production went wrong. Prices were rising at the time and Glencore was locked in below them. The resulting hit was $980m. There should also be a hit, or perhaps more fairly, a query of the credibility of Glencore’s “corporate risk management”, to use the group’s term. Glencore is of course a commodities trader as well as a miner. Its commodity trading division’s adjusted operating profit rose a solid 14%. However, the coal derivative transaction appears to have been undertaken without the expertise of the group’s in-house floor traders.

The hedging theme comes up again in terms of the group’s outlook comments. Glencore motes guidance ranges “reflect the sale of 50% of Glencore Agriculture in December 2016″. In other words, the group is flagging that earnings may begin to show the effect of the disposal of the majority of its agricultural assets during the 2016 financial year. Furthermore, the group lays out the operational conditions it would need in order to achieve the higher range of long-term earnings guidance—$2bn-$3.2bn. Glencore appears to be indirectly cautioning that without a “combination of production/volume growth, uptick in additional working capital, higher interest rates and tighter physical market conditions”, the very best earnings prospects are likely to be off the table.

With ongoing industrial action in Chile impacting all of the world’s mega miners, and the scale of the impact on production now beginning to filter through, Glencore’s reputation as perhaps the least risk-averse mining giant accounts for the modest stock price rise in response to its comeback earnings.

After a triple-digit percentage recovery in just over a year, that reputation, as well as a wider mining and commodity price outlook that calls for caution, will play a large part in deciding the stock’s trajectory from here.

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