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Jon Macaskill is one of the leading capital markets and derivatives journalists, with over 20 years’ experience covering financial markets from London and New York. Most recently he worked at one of the biggest global investment banks |
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But concern is mounting among industry veterans that the latest commodities rush bears one of the hallmarks of other bubbles that ended in disaster for banks: a willingness to cut credit valuation corners in order to win business. Established players say that banks looking to break into commodities dealing are increasingly mispricing the counterparty credit component of derivatives trades with clients. By posting flat prices for commodities trades, regardless of client quality, some banks are allowing themselves to be exploited by canny specialists in individual energy and metals markets.
The slackening of standards is reminiscent of the credit boom of the last decade, when dealers such as Merrill Lynch mystified competitors with their steady accumulation of market share in sectors such as CDOs, only to have their pricing errors exposed in the eventual downturn.
There are compelling reasons to want to win commodities market share at the moment, which help explain apparently illogical pricing decisions.
The current consensus about demand for commodities in 2010 and beyond is not based on a spurious notion of a new paradigm for energy and metals pricing.
It is anchored in anticipation of increased economic activity as the world emerges from recession.
It is also backed by impressive recent price gains in important commodities. Among metals, copper caught the eye with a 140% price rise last year and gold drew the headlines with its drive above $1,000 an ounce. But the doubling of the price of oil from under $40 to more than $80 a barrel in 2009 was the key component of the commodities revival.
Bank commodities businesses vary in their emphasis on different sectors but the biggest players follow a similar pattern. Oil and gas trading accounts for the lion’s share of revenue, emissions are pegged as the great hope for future growth and metals can provide a profitable niche that is never likely to rival energy income.
Banks looking to boost exposure look enviously at Goldman Sachs, which generates more than $3 billion of commodities revenue in a good year. Morgan Stanley is close to a par with Goldman, and Barclays Capital had turned the commodities duopoly into a top three by 2007. JPMorgan has made an aggressive push into the sector in recent years and established itself as number four. Dealers in the pack just below the top four include Bank of America, BNP Paribas, Credit Suisse, Deutsche Bank and Société Générale. Some banks that downscaled in commodities, such as UBS, are now seeking to rebuild. And relative newcomers such as Macquarie and Standard Chartered are looking to expand.
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The growth in the number of would-be commodities players among banks seemed unlikely in the immediate wake of the credit crisis. Some banks that were forced into the arms of their national governments found that their commodities operations provided a source of potential embarrassment and political interference.
The high prices commanded by experienced commodities staff were an unwanted distraction for senior bank executives.
When it emerged that Citi could be on the hook to pay Andrew Hall, the head of its energy trading unit, Phibro, about $100 million for 2009, chief executive Vikram Pandit made a hasty decision to sell Phibro. Pandit offloaded Phibro – and Hall – to Occidental Petroleum for a knockdown price of about $250 million in October. This prompted some predictions that the role played by banks in commodities trading would become much diminished. Big oil producers such as BP and Shell have always had energy trading operations that are at least as significant as those at any bank. And independent oil traders such as Vitol and Trafigura have enjoyed explosive growth from positioning for an oil-price recovery and exploiting contango in forward prices.
But when RBS followed Citi in moving to offload its commodities joint venture, Sempra, healthier banks were at the top of the queue of potential bidders. BNP Paribas fought a prolonged battle for failed Belgian bank Fortis primarily to expand its depositor base, but viewed the accompanying acquisition of Fortis Energy Marketing and Trading as an attraction, not an incidental distraction. The Houston-based trading unit – which was formerly known as Cinergy – is a big gas player, which should supplement BNP’s existing oil capabilities.
Other banks are likely to be tempted to buy energy traders in order to add scale in commodities or to form tie-ups with independent traders, along the lines of the link between Credit Suisse and Glencore.
Banks that are strongly capitalized and came through the credit crisis with their reputations for risk management at least relatively undiminished had hoped to exploit this strength to win commodities client business from Goldman Sachs and Morgan Stanley.
The near-death experience of the two investment banks in late 2008 could be used to pry away commodities business in much the way that their grip on prime brokerage for hedge funds was weakened by the crisis, or so the theory went.
There was indeed some movement to diversify commodity trading counterparties by discriminating clients, but the push into the sector by a growing number of banks that combine a respectable credit rating with a willingness to compete on price is undermining the effect this has on the dominant players in the field.
Goldman and Morgan Stanley retain formidable advantages. Their physical commodity trading capacity was left undisturbed by an emergency shift to bank holding company status in 2008. By paying bonuses that make many competitors blanche they are often able to keep teams intact for far longer than is standard in investment banking. And their scale means that big P&L swings in individual commodities can be absorbed without a threat to the health of their broader franchises.
The failure of the Copenhagen summit in December has delayed a bonanza in emissions trading that some dealers hoped would at last allow them to compete on a level playing field with Goldman and Morgan Stanley. Commodity investment vehicles such as exchange-traded funds are throwing up unexpected complications for banks looking to use them as a way to win market share. And slack counterparty credit controls by some recent entrants are undermining attempts to introduce tiering in commodities client business.
The commodities boom expected in 2010 and beyond seems set to be dominated by familiar faces among banks – although the cast of unexpected casualties from price swings could feature some new names.
