By Jonathan Leff
NEW YORK, Dec 15 (Reuters) - As a historic oil and gas boom
transforms the U.S. energy sector, Wall Street is losing the
battle to remain the partner of choice for energy producers and
major consumers seeking to protect themselves against volatile
In the thriving Texas Permian oil patch and beyond, banks
are being edged out by a handful of the world's biggest
corporations including BP Plc, Cargill and Koch
With Wall Street hamstrung by growing regulatory
restrictions, a recently finalized ban on proprietary trading
and increased capital requirements, these corporate behemoths
are leveraging their robust balance sheets and savvy global
trading desks to capture as much as a quarter of the global
multibillion-dollar market for hedging commodity prices.
New risks have arisen this year that could tilt the scales
further, as the Federal Reserve considers limiting banks'
ability to trade in real physical markets, the kind of deals
that are increasingly important for many of the smaller and
mid-sized companies at the fore of the U.S. energy renaissance.
Just ask Alan Barksdale, president and chief executive of
Red Mountain Resources, a conventional driller in the Permian
Basin. Early this year his company was shopping for a
counterparty to execute derivative trades that would protect
some of its near 900 barrels of daily production from a possible
price drop. Barksdale, a former investment banker, was looking
to lock in "costless collars", a type of specialized options
After reviewing a number of offers, including some from Wall
Street firms, he chose BP Energy Corp, a unit of the oil and gas
major's trading division. In part that was because BP was
already working with the firm's lenders. But Barksdale was also
interested in a partner who could one day take physical delivery
of his crude, potentially netting Red Mountain an extra dollar
or more per barrel.
"As you grow as a company, you'd like some flexibility to
get some physical delivery," Barksdale said. "When you're
dealing with somebody who is long a commodity, you get better
Ten years ago, only a handful of banks would have likely
handled such a trade. Over the past decade, however, more than a
dozen rushed into the commodity trading business, acting as
lenders, counterparties and risk managers.
Now some of the biggest are beating a hasty retreat.
Deutsche Bank became the largest victim last week,
announcing plans to exit most trading under mounting regulatory
pressure and diminished profitability.
Others are like JPMorgan Chase & Co and Morgan
Stanley are poised to carve out their large physical
trading operations - things like oil storage tanks, gasoline
cargoes and power plants - but will still compete fiercely on
derivatives deals, trades they can combine with financing or
other activities. Goldman Sachs has been resolute that
the bank will continue trade both cash and paper commodities.
While most banks have blamed regulations and lower market
volatility for the sharp slump in commodity earnings, at least a
portion of the decline appears to stem from the corporate giants
quietly stealing banks' core business: serving clients.
Commodity revenues at the world's top 10 investment banks
has fallen from a peak of more than $14 billion in 2008 to just
$5.5 billion last year, according to consultants Coalition. One
senior executive at a top 10 commodity bank said corporations
had taken as much as a quarter of the global hedge book away
from banks, including deals with airlines and utilities.
"When you look at the market overall, the commercial firms
are making in-roads into the hedging business," says Andy Awad
of Greenwich Associates, which conducts an annual survey of
hundreds of companies that hedge commodity prices. "I would
imagine the pace of change is going to increase."
While the big non-bank companies have not yet cracked the
top tier, four of them made it into the top 20 U.S. energy
hedgers this year, he said.
RETURN OF THE CORPORATES
As banks withdraw, the conventional wisdom has been that
foreign, privately owned commodity merchants like Vitol and
Trafigura - which typically trade only for themselves - would
fill the market void, particularly in the costly, complex realm
of physical trading.
While they may help bolster liquidity, most of those firms
are loathe to take on the onerous regulatory burden now required
to become a major derivatives trader.
Yet this year, units of BP, Royal Dutch Shell and
Cargill all formally entered the big leagues of derivative
dealing, registering as "swap dealers" alongside dozens of the
world's biggest banks. As the most heavily regulated type of
derivatives trader under the Dodd-Frank law's financial reforms,
they face onerous record-keeping and trade reporting rules, but
also have the latitude to hedge with far more clients, and to
trade in excess of $8 billion in swaps a year.
To be sure, banks retain many advantages in the business. As
the leading lenders to the world's industries, they can offer
bundled services and leverage existing lines of credit; the
derivatives operations of the biggest players, even those
selling some parts such as JPMorgan, remain competitive on
Yet they are suffering set-backs across multiple fronts.
Some of their most valuable traders are now being hired away
by private merchants who can offer higher salaries and bigger
bonuses. Tougher capital requirements under the Basel III
international accord are raising banks' funding costs and
narrowing profit margins.
"We have a strong balance sheet and an ability to manage
these price risks," said Cody Moore, head of North American Gas
and Power at EDF Trading, a unit of France's government-backed
The group was formed in 1998 and expanded its international
reach ten years later with the purchase of Lehman Brothers'
physical trading unit Eagle Energy during the financial crisis.
Its revenue has surged 60 percent since 2008; pre-tax profits at
the firm, one of the few to separate its financial performance
from that of the parent group, reached nearly 500 million euros
With some 350 people in its Houston office alone, EDF
Trading is now the leading energy management provider for power
generators in the United States. Last year it hired a small team
to expand into oil market logistics.
Corporations have another advantage - unlike banks, they are
not banned from trading with their own money.
Under the Volcker Rule, which was formally approved by
regulators this month, banks can no longer engage in proprietary
derivatives trading - giving them less incentive to chase
customers simply for the benefit of valuable insight into a
particular trend they may be able to trade themselves.
"In the past, the information was worth something to a bank
if you had a proprietary desk," says Eric Melvin, a former
trader at an investment bank who now runs boutique Houston-based
risk-advisory firm Mobius Risk Group.
He estimates that investment banks now account for only
about half of the U.S. oil and gas-hedging business, with
corporate merchants accounting for some 40 percent, up from
almost nothing just a few years ago.
For most of these companies, one of their biggest selling
points is the ability to manage the risk of some of the most
esoteric or niche energy markets in the world - typically
because they already trade those commodities for themselves.
"We're willing to stand in as a provider of risk-management
where many or most others won't," says Steve Provenzano, BP
Energy's Chief Commercial Officer for client hedging in the
Americas. "Obviously our involvement in the physical business
gives us credibility."
Long the largest U.S. natural gas trader and a major global
oil operator, BP also has 20 people who help arrange customer
derivatives trades in North American alone, and more than 3,000
wholesale customer worldwide, he said.
While Wall Street awaits the completion of a Federal Reserve
review of commodities trading - the results of which are
expected early next year - corporations that hedge energy prices
are placing a greater importance on the ability of a
counterparty to trade in physical markets, according to
Greenwich Associates' latest survey.
"I think what we're seeing is that people recognize you
can't divorce the financial and physical, they're linked," says
Meanwhile competitors are stealing a march.
Minneapolis-based Cargill, better known for its prowess in
agricultural markets, has recently moved its Houston trading
group to a larger office with room for over 100 traders, online
industry publication SparkSpread.com reported this month.
Cargill employs more than 1,000 people in its Geneva-based
Energy, Transportation and Metals business, and executives have
said they are looking to expand as others divest.
A spokesman for Cargill declined to comment on the business.
Koch Supply & Trading, a unit of the $115 billion a year
conglomerate owned by Charles and David Koch, is famed for
having traded the first oil swap over 25 years ago, and says it
now has nearly 500 traders, marketers and energy and metal
markets professionals worldwide. It expanded its European
natural gas team last year, and minces no words in promoting
itself as a more constant alternative to Wall Street.
"While some financial institutions' market coverage varies
with global market cycles, KS&T companies take a longer term
view," it says in a recent online brochure. Koch offers market
liquidity "at times when others pull back."