Commodity market competition enters bold new era
By Javier Blas in London
Published: November 27 2008 17:09 | Last updated: November 27 2008 17:09
Goldman Sachs and Morgan Stanley have dominated the commodities business for almost two decades, but for the first time their de-facto duopoly is under threat.
The credit crunch has forced the two Wall Street banks, which dominate all areas of commodities, from taking clients’ risk and hedging positions to proprietary trading, to adopt a more cautious approach.
That is creating an opportunity for other players. Barclays Capital and JP Morgan are the best placed, bankers say, But even smaller operations such as RBS Sempra, Deutsche Bank, Credit Suisse and Société Générale are set to benefit. Merrill Lynch’s path is unclear after its recent merger with Bank of America.
Whether others will be able to fully replicate the success of Goldman and Morgan remains to be seen.
Both banks are set to achieve record revenues – before taxes and other expenses – of about $3bn from their commodities business this year, taking about half the estimated $12bn revenue pool earned by the sector.
However, both have lost clients and curtailed some operations as part of a deliberate strategy to cut risk and preserve cash, bankers say. Their competitors are eager to seize the opportunity to take market share.
“Do I think we’re going to significantly close the gap between us and our competitors? Yes, absolutely I do,” says David Silbert, global head of commodities at Deutsche Bank. “There is tremendous opportunity to gain ground in 2009,” he adds.
Rather than losing their leadership, Goldman and Morgan are more likely to see other banks creeping closer to their position.
The fight for market share is even more important as bankers agree that commodities will provide a more important source of revenues in future now that the credit crunch has decimated other income streams, such as credit derivatives. Commodities usually form part of banks’ fixed income divisions, together with credit and currencies.
Adam Knight, co-head of global commodities at Credit Suisse, says banks will be “significantly disadvantaged” if do not build strong commodities businesses.
“The contribution of commodities revenues to overall fixed income revenues is significant and will likely continue to be so,” he says.
Most banks agree with this view. Many have expanded their commodities businesses in the last few years, taking advantage of a strong recovery in the cycle since 2003 and replicating the early move by Goldman and Morgan in the 1990s.
The most advanced is Barclays, currently number three, with about $2bn in revenues, and JP Morgan, ranked fourth, with revenues above $1bn. Both have significantly expanded their capacity by acquiring the commodities businesses of Lehman Brothers and Bear Stearns respectively.
Barclays has seen strong growth in the last couple of years, but the last three months have provided an additional boost, says Roger Jones, co-head of commodities. “We have seen an increase in flows and clients since the credit dislocation started with customers more concerned about counterparty risk and the strength of the balance sheet,” he says.
Blythe Masters, head of commodities at JP Morgan, also says that the bank is gaining market share. “The acquisition of Bear Stearns has made a huge difference in our business,” she says.
Acquiring Bear Stearns has almost doubled JP Morgan’s commodities staff to 450. It has also provided a huge presence in the <bimportant US’ natural gas and power markets from Bear’s base in Houston. Ms Masters has also hired some top traders from rivals – such as Oral Dawe and Ouyang Xiuzhang, previously senior commodities executives with Goldman in Asia.
The financial crisis has also created a rare opportunity for banks to obtain physical assets, such as power plants or sugar processing facilities, replicating tactics employed by Goldman and Morgan in the late 1990s.
Mr Jones of Barclays says this is the moment to look for physical assets such as oil storage capacity, export terminals and pipelines. “There will be no better time – if you look at asset valuations, they are a lot more interesting now than in the last few years.”
But both banks faces challenges – Barclays’ capital costs have increased while JP Morgan is continuing to digest Bear Stearns large commodities business.
The challenge for smaller players will be to navigate this market without strong internal liquidity. The capability to offset opposing trades from clients within the bank is an important risk management tool. For example, a bank might try to match internally the requirements of an oil company seeking to lock in a price for its output with an airline looking to hedge the cost of its fuel.
If a bank cannot offset trades internally, it then has to offload the net risk in the secondary market, but liquidity there has dropped to its weakest level since 2001.
Next year promises to be even more challenging with overall bank commodity revenues expected to fall from $12bn to $8bn, the first drop since 2002. Nevertheless, the reduction in activity could be partially offset by wider margins as risk in the commodities business is repriced.
Goldman and Morgan both face a new regulatory enviroment in 2009 under the umbrella of the US Federal Reserve, after they converted into bank holding companies in September. The other players already operate their commodities business under the same regime.
Colin Bryce, global co-head of commodities at Morgan Stanley, does not foresee any problems. “We don’t anticipate any significant changes in our business model and strongly believe that one of our core areas of growth is commodities,” Mr Bryce says. Goldman declined to comment.
Even if the new regulatory enviroment does not trigger changes, Goldman and Morgan face a mounting challenge from increasingly bold competitors.
Copyright The Financial Times Limited 2008 |
