For third time in five years, one of the world's biggest commodity trading desks is for sale.
JPMorgan Chase & Co. said on Friday it would seek 'strategic alternatives' for its physical oil, gas, power and metals trading division, the core of which is a group that's already been through two ownership changes since 2008.
It was a surprise about-face for a bank that spent billions of dollars over the past five years assembling the largest physical trading platform on Wall Street.
On paper, it seems the perfect one-stop shop for a financial rival looking to buy into the world of pipelines and pallets: a global oil trading division includes a contract supplying the biggest refinery on the East Coast; Henry Bath & Sons Ltd's 72 metal warehouses from Baltimore to Busan; a U.S. natural gas book three times larger than that of any other bank; and enough electricity contracts to light up Indiana.
Yet while other banks have often competed with JPMorgan as it acquired parts of Bear Stearns, UBS and RBS Sempra, this time around -- with a few exceptions -- they are more likely selling.
Other U.S. and European banks face the same rising capital requirements, regulatory pressures and narrowing margins that are driving JPMorgan to quit the business, hearkening the end of an era in which banks raced to get into the physical trade.
Since March, Goldman Sachs has floated selling its warehousing business Metro International Trade Services LLC, a rival to JPMorgan's Henry Bath. For more than a year, Morgan Stanley has tried, in vain, to sell its vast oil pipeline and terminals business TransMontaigne. It faces a September deadline from the Federal Reserve for a make-or-break decision over whether it will be able to keep the operation.
"Ultimately this is going to be a hard sale," one industry banker said of J.P. Morgan's offer to sell. "Look at what happened with Morgan Stanley's commodity business."
Bankers and industry sources said potential buyers could come from one of several areas: foreign banks like Brazil's BTG Pactual or Macquarie that are not subject to Fed regulations; merchant traders like Vitol or Mercuria that are expanding into metals markets; or wealthy, risk-hungry investors such as private equity and sovereign wealth funds, both of which have delved into commodity trading in recent years.
The operation is so vast and diverse that it may be hard to find a single buyer, forcing JPMorgan to split the units.
"I don't know that anyone will buy it lock stock and barrel. Perhaps the energy desk will go to a hedge fund but it has to be somebody with credit and trading lines for a physical company," said Ed Meir, an analyst at brokerage INTL FCStone.
JPMorgan has said it may seek a joint venture, spin-out or sale, but has not said whether it will seek to keep the division whole or sell it in parts. But it has the luxury of some time.
Now that it has openly announced selling the group, it should have until July of 2015 to meet a Federal Reserve five-year grace period for divesting the Henry Bath unit.
One thing after another
JPMorgan bought Bear Stearns in 2008, inheriting a huge electricity desk and power plants as the financial crisis loomed. A year later it bought the global agricultural and Canadian energy businesses of UBS, which was quitting the market several years after buying remnants of failed merchant Enron.
The crowning achievement for Commodities chief Blythe Masters came in 2010, when JPMorgan paid $1.7 billion for the metals and oil divisions of RBS Sempra Commodities. Eurpoean regulators forced the Royal Bank of Scotland to sell its stake to gain approval from Brussels for a state bailout. RBS had paid $1.35 billion for a 51 per cent stake just two years earlier.
Now it is JPMorgan who is under pressure on multiple fronts. The bank is said to be in talks over a $400 million deal to settle allegations that it manipulated power markets; the metals warehousing industry is under public and political scrutiny over allegations that long queues are driving up prices.
And as of last week, the Federal Reserve is reconsidering a landmark 2003 decision that first allowed banks to trade physical commodities, in addition to traditional derivatives.
None of those factors may deter certain new players, particularly those who choose not to establish commercial banking operations in the United States, allowing them to remain outside of the Fed's limits on commodity trade.
Brazil's BTG Pactual has made little secret in recent months of its desire to build a big presence in the market, hiring former Noble Group chief executive Ricardo Leiman to jump-start a major new expansion by recruiting traders on both sides of the Atlantic, according to industry sources.
The bank has declined to comment on its plans.
Australia's Macquarie Group has also built up a major presence in U.S. gas, power and oil markets over the past five years, with a 160-strong trading desk in Houston, and dipped a toe into the metals warehousing business by joining hedge fund Red Kite in buying a stake in Scale Distribution, a small firm that runs an LME warehouse in Liverpool.
Macquarie had expressed interest in Henry Bath and the former Sempra physical metals team when it was up for sale in 2010, sources said at the time. So had Deutsche Bank, which has since scaled back sharply in physical U.S. and European trade.
The Australian bank may also make a natural buyer for some of JPMorgan's energy assets.
A bank spokesperson declined to comment.
Another contender may be Noble Group, the ambitious Hong Kong-based merchant that has tried for several years to expand globally, particularly in energy and metals markets. This month it hired JPMorgan's long-time head of global oil trading Jeff Frase, a veteran Goldman trader, and poached Morgan Stanley's top European crude traders.
In 2010, it bought a small U.S. company, Worldwide Warehouse Solutions, which has expanded to 13 LME warehouses, including in Singapore and the Netherlands. It also hired several big traders over the past year to broaden its metals desk.
A spokesperson could not immediately be reached for comment.
At one time, the crown jewel of the business would have been Henry Bath & Sons, a metals and soft commodity warehousing firm based in Liverpool, Britain that is nearly 220 years old.
Three years ago, JPM told regulators Henry Bath stored between 20 and 30 percent of metal stored in the LME's warehousing network in 2009. That was as much as 1.7 million tonnes of base metals, according to Reuters calculations, equivalent to 9 percent of global annual copper use.
It booked profits of $113 million that year, almost four times 2008, as a glut of metal piled up during the world economic crisis. In 2010, just as JPMorgan was buying Sempra, Goldman Sachs paid more than $500 million for smaller rival Metro and Glencore bought Pacorini Metals.
But profits have ebbed as metals stocks have thinned, and competition from Goldman and Glencore Xstrata increased. In 2011, Henry Bath posted net profit of $27 million. The company has slipped from No. 2 to No. 4 in the LME system.
Bankers noted that two of the world's biggest oil traders, both based in Switzerland, had expanded into base metals in the past year. Vitol hired veteran trader Roger Pillai; Mercuria hired Mike Harrison from Standard Bank.
But their appetite to enter the warehousing business is uncertain at a time when the LME has proposed sweeping reform of its warehousing policy that are meant to reduce wait times and placate irate industrial users who complain about lengthy queues for delivery, but probably will also hit profit.
The LME board will vote on its proposal in October and the change would be implemented next April.
A senior Vitol executive said the company was not likely to be interested in JPMorgan's physical businesses.
"I'm not sure who it fits," the executive said.
Last year, JPMorgan sold its metals concentrates trading team to private equity-backed start-up Freepoint Commodities in order to comply with Fed regulations. As an LME ring-dealing, the world's largest metals market, JPMorgan is also one of the largest metals brokers.
In the physical energy markets, JPMorgan had leapfrogged its rivals by this year. It became the first bank in more than a decade to surpass Morgan Stanley as the biggest U.S. oil importer due to last year's deal to supply crude to a 330,000 barrel per day (bpd) Philadelphia refinery and a smaller contract to supply Northern Tier's Minnesota plant.
JPMorgan traded nearly 3,000 trillion British thermal units (Tbtu) of physical natural gas last year, making it the eighth-largest players in the market, according to data reported to the U.S. Federal Energy Regulatory Commission. That was down 17 percent from 2011 but still triple its nearest rival Goldman.
The energy market has been the largest and most attractive for investors, but enthusiasm may wane due to a FERC crackdown on U.S. electricity trading, lower volatility in oil and natural gas and signs of growing European oversight of physical markets.
And here too the market is crowded.
If you are looking for a purely proprietary physical energy trading shop with global reach, what about Hess Energy Trading Co. (Hetco), the joint-venture being sold off by Hess? For a domestic U.S. operation in good position to trade the booming business of shale and ethanol, how about Gavilon's oil division, spun out from Marubeni's takeover this summer?
Ultimately, potential buyers must try to value the intellectual capital of an energy group that owns few assets, with few guarantees the talent will stick around after a sale.
"My feeling is large traders will not buy banks' businesses, at best they can hire some of the better individuals there, but I don't see it any further than that," said one senior executive with a major merchant trader.
Despite the obstacles, JPMorgan hopes this sale will turn out better than the last time it tried to sell an energy unit.
In mid-1998, after a five-year effort to get into physical energy trading, the bank said it would sell the 35-person division, which included a large European crude desk. Six months later it folded the group, having failed to find a buyer.
Copyright: Thomson Reuters 2013