The Terrible Tale Of Two Commodity Catch-22s

How the mighty have fallen! Last week, one of the world’s commodities giants, Glencore Plc (GLNCY), experienced a major blow.

On September 28, its stock collapsed by 30%. The reason? The company’s very heavy debt load in the face of still falling commodity prices.

The former commodities trading giant went public in a $60-billion stock market flotation four years ago. At the time, its traders transacted 60% of the world’s zinc, 50% of the copper, and 45% of the lead.

It became a physical commodities powerhouse when its head, Ivan Glasenberg, forced a merger with one of the world’s biggest miners, Xstrata, in 2013.

But now, its shares are down more than 80% from the issue price. And worries persist in the market that Glencore may be the next Lehman Brothers.

A Back-Breaking Debt Load

That particular fear may be overblown.

You see, Lehman Brothers may have had up to a trillion dollars in derivatives exposure.

Glencore does have about $100 billion in liabilities including $30 billion in net debt. Not good when your market capitalization is down to less than $20 billion. And the debt is 2.7 times annual earnings.

However, Glencore’s derivatives exposure is more limited than Lehman Brothers’. It’s believed to have a bit over $10 billion in derivative assets and close to $12 billion in derivative liabilities. Scary, but not Lehman. It may have had up to a trillion dollars in gross over-the-counter derivatives trades.

Its real problem is how to service that $30 billion in debt while commodities tumble. In effect, with each slide in commodities, Glencore’s leverage grows as its assets shrink, sinking the company further into quicksand.

Glencore is in a quagmire of its own doing. Most in the industry point to the $60-billion (including debt) acquisition of Xstrata as the turning point. Glencore took on a lot of debt for assets that weren’t all that great. Most of Glencore’s other mining assets are in the high-cost, low-quality variety.