A big bank investing in commodities trading is a rare move these days. According to London-based consulting firm Coalition, industrywide revenue has shrunk by two thirds since 2008, to $4.5 billion in 2013, as onetime commodities leaders such as JPMorgan Chase & Co. and Morgan Stanley have been selling off hunks of their businesses and scaling down the rest.
But Citigroup bucked the trend last month, buying a commodities trading book from Deutsche Bank, which had announced it would exit the shrinking sector. Citi confirmed the transaction for Institutional Investor but declined to name a price. The purchase was part of a larger buildup that already saw Citi’s commodities trading revenue jump threefold, to $267 million, between 2011 and 2013, according to Coalition. Says Stuart Staley, Citi’s head of global commodities, the bank is not so much being contrarian as shifting toward its strengths as a commercial bank that can offer hedges on oil, power or metals as an add-on for multinational corporate borrowers. “We are doing what banks do — helping to manage risks involved in the flow of capital,” Staley explains.
Two principal factors have driven the denuding of Wall Street’s commodities desks since the Lehman Brothers Holdings bankruptcy in September 2008. The more obvious of the two is prices for oil and metals, which plunged after Lehman’s collapse, rebounded, then have slumped steadily starting in early 2011. Investors who rushed to make speculative trades in the boom years turned en masse back to stocks and bonds. “From about 2003 to 2011, investors and banks both got caught in the marketing hype about a commodities supercycle,” says Jeffrey Christian, managing partner of CPM Group, a New York–based research firm that advises corporations on commodities. “We are in the backwash of that now.”
The second key factor has been increased regulation and enforcement , mostly in the U.S., as legislation such as the Dodd-Frank Wall Street Reform and Consumer Protection Act handed the government new instruments for oversight of commodities markets. But regulators’ ire has focused largely on firms that went beyond a traditional trading role to control physical commodities assets or productive capacity, says George Kuznetsov, Coalition’s chief of research.
Take JPMorgan Ventures Energy Corp., which effectively controlled a string of power plants through financial agreements with utilities. The structure left JPMorgan open to U.S. Federal Energy Regulatory Commission (FERC) allegations that the bank was using vertical market power to bilk consumers. JPMorgan paid $410 million in fines, neither admitting nor denying any wrongdoing. In 2013 the FERC fined Barclays, another traditional leader in commodities, $488 million on charges that it was allegedly trying to manipulate energy prices in California in 2012. The fine was handed down in 2013, with the U.K. banking giant fighting the penalty in U.S. courts.
Not surprisingly, banks have been fleeing the physical commodities space in the face of this crackdown plus sagging prices. J.P. Morgan exited its power ventures and sold off its oil and metals businesses this year to Mercuria, a privately owned trading firm based in Geneva. Morgan Stanley agreed to dispose of its physical oil business to Russia’s Rosneft, though the transaction is on hold as the state-owned behemoth faces Ukraine-related economic sanctions.
This retreat from the boom-era integrated model leaves some market share open for players like Citi, which focus on commodities services as part of larger corporate relationships, Coalition’s Kuznetsov says. A small roster of players across the globe are looking for similar expansion: BNP Paribas in Europe; Brazilian lender BTG Pactual in Latin America; and Standard Chartered Bank, which is headquartered in London but is most active in Asia. “What all the banks that are expanding in commodities have in common is strong links with corporate clients,” Kuznetsov observes. “They can use the situation on the market as an opportunity.”
The dive in world oil prices over the past several weeks will also add a little zest to commodities trading, as clients scurry to hedge against a wider range of future outlooks for their fuel costs, observers say. Still, the glory days of the business are a long way from returning. Volatility may be the trader’s friend, but financiers thrive most when raw materials companies are investing in new wells and mines, which can be a target for lending. Oil and copper prices hovering at four-year lows do not encourage these multibillion-dollar expenditures, however.
New regulation is also a stifling factor across the commodities board, though it may hit harder on physical than derivatives trading, CPM Group’s Christian argues. “It’s not unusual to go to a bank these days and see more compliance and risk managers than traders on the desk,” he says. “That means costs have skyrocketed in what were always relatively small markets.”
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