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Welcome to the New World of Physical Commodities Trading & Wealth Creation

By : Ziad K Abdelnour| 21 April 2014
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As JPMorgan Chase & Co has now exited the physical commodities trading business, one wonders what the future of the business at large – along with the one of the two major banks that have dominated Wall Street’s involvement in the natural resources supply chain for 30 years – will be, particularly when it comes to Goldman Sachs and Morgan Stanley; the ultimate “Wall Street Refiners”.

Goldman Sachs and Morgan Stanley may hold one advantage over JPMorgan, as their long history of operating in physical commodities as less regulated banks may provide them with “grandfathered” ownership of assets like warehouses, pipelines and storage tanks that other commercial banks aren’t allowed…I am afraid though this advantage is clearly narrowing by the day.

It is a fact that since 2012 Morgan Stanley has looked at selling its commodity arm and Goldman has made moves to scale back its physical operations.

Market deterioration has also complicated matters. Since hitting its all-time high in July 2008, the benchmark Goldman Sachs Commodities Index has dropped 57 percent, creating losses in some physical arenas and driving many of the banks’ key institutional investors out of the asset class.

Given those seismic changes in the marketplace coming to hit us all, I foresee many more commercial bank divestitures in the years ahead as the U.S Senate will probe more than ever whether banks should be allowed to own pipelines, warehouses and other commercial assets. The Fed after all wants those banks to conform their business activities to the Bank Holding Company Act.

I also foresee even major investment banks getting out of their peripheral business and refocusing only on their core physical oil trading arm. In fact, I believe the commodities business of the future will most likely devolve to its financing and risk management core and the banks will be less active in the physical markets. Wall Street will just become “paper traders”.

The $64,000 question that remains though is whether banks will be able to choose their own future, or will the Federal Reserve’s decision to review the entire role of Wall Street in physical commodities markets see regulators make the choice for them?

At the end of the day, I suppose that the increasing capital strains on banks, and especially the political heat being directed at the industry may not be worth fighting for given the slimmer profits derived from playing the physical trading market at most banks today…. Adding to that the fact that the Fed is also considering imposing a surcharge on bank commodities holdings linked to the amount of capital they require or risk they take, though no formal decisions have been made.

So who’s the most likely new guard ready, willing and able to take over the industry by storm?

It is clear to everyone by now that the top tier private equity groups such as Carlyle and the like are already replacing the commercial and investment banks holding and trading such assets.

Major oil companies are selling more than $300 billion of assets, according to Carlyle International Energy Partners. So no wonder we will see more private-equity companies, commodity traders and sovereign-wealth funds buying more energy infrastructure from oil companies shifting to expensive exploration and production projects.

Big merchant commodity firms like Glencore Xstrata and Trafigura are also positioned to tremendously capitalize on such opportunities.

Varo Energy, Carlyle’s venture with commodity trader Vitol Group that owns Switzerland’s Cressier refinery, is already considering buying a stake in a plant in southern Germany. The joint venture plans to become a “new player” in oil refining and storage in northwest Europe focusing on output of the middle-distillate fuels such as diesel and heating oil that the continent now imports to meet its needs.

Global commodity traders are also already massively investing in infrastructure to expand their trading opportunities and secure supplies; same goes for sovereign wealth funds teaming up with commodity traders to fund purchases of energy assets. Many more players are positioning themselves very aggressively in Africa and Southeast Asia. Not sure yet about North America as regulators are not helping lure such players to our shores.

A private money manager like a sovereign-wealth fund might still lack the interest and the expertise to manage a 10-year oil delivery contract with a major driller —smart traders though learn fast.

Welcome to the new “wealth creators” in the making.

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