J.P. Morgan to Sell Commodities Business

Updated July 26, 2013, 7:54 p.m. ET

J.P. Morgan to Sell Commodities Business

Move Comes Amid Regulatory Scrutiny of Wall Street



NEW YORK—The largest U.S. bank is getting out of the power-plant and warehouse business, amid heightened regulatory scrutiny of Wall Street’s ownership of such assets. J.P. Morgan Chase JPM -0.80% & Co. said Friday it is putting its physical commodities operation up for sale, a major retreat for a company that last decade made a costly and bold effort to become No. 1 in the commodities field. J.P. Morgan joins rivals Goldman Sachs Group Inc. GS -0.39% and Morgan Stanley,MS -0.22%  which also are seeking buyers for such holdings. Regulators in recent months have ratcheted up scrutiny of banks’ power-market operations. The Federal Energy Regulatory Commission’s enforcement staff in March accused J.P. Morgan of manipulating energy markets in California and the Midwest. J.P. Morgan denied the accusations in a written response to FERC. The company is negotiating a $410 million settlement that would resolve those allegations. The Federal Reserve, meanwhile, is reviewing a decade-old policy allowing banks to hold physical commodity assets.J.P. Morgan’s decision is the most striking move yet by Wall Street to back away from physical commodities, marking a potential final chapter in a decadelong push by financial firms to seek profits by planting themselves at the center of the global supply chain for industrial materials.

Such firms in recent years moved into the ownership of everything from oil pipelines and metals warehouses to barges and wind farms. But lawmakers and major metals users such as MillerCoors LLC accused banks of sometimes withholding supplies and driving up their costs. In early 2008, some consumer advocates alleged that banks’ use of tankers contributed to skyrocketing oil prices at that time.

J.P. Morgan is “obviously sensitive to all this blowback that’s coming from Washington,” said Edward Meir, senior commodities analyst with futures brokerage INTL FCStone.

In a statement, J.P. Morgan said it “has built a leading commodities franchise in recent years, achieving a top-ranked revenue position.” The bank added that it “will remain fully committed to its traditional banking activities in the commodity markets.”

The storing of products ranging from aluminum to steel in warehouses around the world isn’t a core business for the banks, nor is the buying and selling of energy for power plants. Through the first half of the year, such holdings contributed less than $700 million to J.P. Morgan’s $50 billion in revenue, and the business employs less than 1% of its 254,000-person workforce.

But J.P. Morgan at times has been a massive holder of physical commodities. In December 2010, J.P. Morgan amassed a copper stockpile of more than 175,000 tons. It exceeded $1 billion in value at the time and accounted for more than half of all the metal stored in London warehouses, the global hub of base metals trading. The bank said then that most of the purchases were on behalf of clients.

Likewise, J.P. Morgan’s 2010 purchase of Henry Bath & Son Ltd., a metal warehousing network, gave it more than 70 facilities on four continents from New Orleans to Singapore—nearly 11% of the industry total, according to London Metal Exchange data this month.

J.P. Morgan also is the biggest bank in the natural-gas-storage business, according to an analysis of government data by BNP Paribas earlier this year. J.P. Morgan leased about 25 billion cubic feet of natural-gas storage as of the end of the first quarter. The figure includes only storage owned by interstate pipelines, so the total volume of storage may be higher. Bank of America Corp.’s commodities unit was second, with leases to about 16 billion cubic feet of gas storage.

Sen. Sherrod Brown (D., Ohio), who held a hearing on such matters Tuesday, said J.P. Morgan’s announcement could be good news for consumers and taxpayers. “Banks should focus on core banking activities. Our economy is strengthened when financial conflicts of interest and financial risk are reduced,” Mr. Brown said in a statement.

For decades, the U.S. had legal prohibitions on bank ownership of commercial assets to maintain separation between banking and commerce—both to insulate banks from risk and to prevent concentration of financial and economic power that would allow banks to potentially distort markets.

But beginning with bank deregulation in the 1990s and continuing with one-off permissions granted by the Fed throughout the 2000s, regulators allowed banks to expand their participation in physical commodity markets and ownership of physical commodity assets.

The Fed granted permission for banks to expand their roles in physical markets beginning with Citigroup Inc. in 2003. A handful of others followed over the next several years as Goldman Sachs and Morgan Stanley also bought assets such as pipelines, warehouses and power plants.

One attraction was that such businesses allowed banks an early look at information on supply and demand. They could profit by seeing the flow of raw materials and trading based on that plus their added knowledge of financial markets. The physical commodity business generated more than $1 billion for banks, or 15% of total revenue from raw materials, in 2012, with oil-related business representing easily half of that, according to research firm Coalition.

Inside J.P. Morgan, the commodities business became one of the bank’s biggest bets. It spent more than $2 billion acquiring commodities-trading operations, including those of securities firm Bear Stearns Cos., parts of UBS Commodities and, most recently, assets from RBS Sempra Commodities in 2010.

J.P. Morgan Chase tapped Blythe Masters, one of the best-known women on Wall Street, to run the business. It isn’t known what Friday’s decision means for Ms. Masters. She intends to help the firm look for potential buyers, but it is too early to know what she will do afterward, said a person familiar with the situation.

The bank also intends to sell trading desks that buy and sell oil, gas, power and coal. It will continue to hold gold and silver in vaults even if it sells the other physical assets, this person said.

Wall Street firms’ decisions to unload many of their commodity assets is coming amid mounting criticism of banks’ ownership of such holdings.

“It reminds me of the potential for problems that occurred when Enron was both supplying electricity and running electricity-trading markets,” Sen. Jeff Merkley (D., Ore.) told Fed chairman Ben Bernanke during a banking committee hearing last year, calling the multiple roles “a substantial conflict of interest.”

Another factor is a steep decline in the business. Commodity revenue is down across the industry by some 50% over the past five years.

Markets have moderated, providing fewer opportunities for trading profits, and the most lucrative part of the business—providing complex structured hedging trades to corporate clients—has also declined, according to consulting firm Tricumen.

J.P. Morgan’s revenue from commodities through the first six months is running behind the company’s goals for the year, said people familiar with the performance.

“They’re seeing the handwriting on the wall because they see commodity trading volumes have been dropping,” said Mr. Meir of INTL FCStone.

JPMorgan Commodities Exit May Sap Liquidity Until Others Step in

A decision by JPMorgan & Chase Co. to exit its physical commodities business would temporarily reduce market liquidity before other companies quickly take its place, according to analysts and traders.

New York-based JPMorgan, the largest U.S. bank, said yesterday that it’s “pursuing strategic alternatives,” including the sale or spinoff of its commodities business, after an internal review. The statement came three days after a congressional hearing investigated whether deposit-taking banks should be allowed to trade raw materials such as oil and industrial metals.

JPMorgan owns and trades financial and physical commodities including crude oil, natural gas and power, and describes itself as “one of the world’s leading energy market makers.” The bank may be the first to exit physical commodities, though others may follow if regulations are changed, as suggested by Senator Sherrod Brown, an Ohio Democrat whose subcommittee of the Senate Banking Committee held the July 23 hearing.

“It looks like they want to get ahead of what appears to be a new wave of regulation that will limit the activities of the banks in the commodities sphere,” said John Kilduff, a partner at Again Capital LLC, a New York hedge fund that focuses on energy.

Regulators need to take a “long, hard look at the practice of banks holding physical commodities,” Brown said in a statement before the hearing. JPMorgan’s decision to consider selling or spinning off its commodities business is “good news for consumers and taxpayers,” he said in an e-mail yesterday.

Liquidity Drop

While the exit of JPMorgan and other banks may reduce liquidity in the short term, they will be replaced by commodities-trading firms such as Switzerland-based Glencore Xstrata Plc., Kilduff said.

“Maybe JPMorgan is just getting ahead of the game a little bit,” said Tariq Zahir, a New York-based commodity fund manager at Tyche Capital Advisors. “Commodities have been part of their business, but not a big driver of their revenue. If Goldman or Morgan Stanley decides to get out of commodities, people will definitely take more notice of that.”

The effect on the market of JPMorgan’s exit may depend on whether the commodities business finds a new life, either on its own or in the arms of a buyer.

“If JPMorgan were to sell or spin off the physical commodities business and it became a new entity, the impact on the market would be minimal,” said Andy Lipow, president of Lipow Oil Associates LLC in Houston. “If JPMorgan were to just shut it or sell to someone with the same business, that may sap liquidity from the market.”

Metal Warehouses

The congressional inquiry came three weeks after the London Metal Exchange said it wants to help unclog growing queues at repositories, which companies ranging from beer makers to wire fabricators say have reduced the availability of aluminum and copper.

At the same time, prospects for gains in commodity prices may be dimming. Analysts at banks from Citigroup Inc. to Goldman Sachs Inc. have said the decade-long commodity bull market is ending after higher prices spurred expansions at mines, farms and oil fields.

Increased regulatory scrutiny of banks and commodities, along with the outlook for lackluster gains in many raw materials, provides a “one-two punch,” to bank commodity businesses, John Stephenson, who helps oversee about C$2.7 billion ($2.6 billion) at First Asset Investment Management Inc. in Toronto, said in a telephone interview.

“The banks are saying ‘I don’t need the hassle, and there’s no money to be made anyhow,” Stephenson said. “If it was the only game in town, and you were printing money, and there were just a few pesky regulators hanging around, that would be another thing. But with the light being shone now, the implications are very negative.”

To contact the reporters on this story: Edward Welsch in Calgary at ewelsch1@bloomberg.net; Joe Richter in New York at jrichter1@bloomberg.net.

July 26, 2013 4:56 pm

A ban on banks holding physical commodities could backfire

By Gregory Meyer

Arguments for revoking 2003 Federal Reserve rules are flawed

In 2012, the banking industry commissioned a study in the hope of showing commodity trading houses such as Glencore and Vitol were too big to fail.

The shoe is now uncomfortably on the other foot, as a policy debate over what big banks are doing in the murky world of commodities erupted this week. The end result may be the opposite of what the banks wanted: Goldman Sachs, JPMorgan Chase and Morgan Stanley may no longer be able to touch oil, gas or copper.

Banning Wall Street banks from holding physical commodities might be a victory for advocates of a separation of finance and commerce, a bedrock of US banking law. But many of their arguments are flawed, and it would come at a cost.

The Federal Reserve has since 2003 allowed the largest bank holding companies to trade physical commodities – tanks full of crude, not just oil futures. Goldman and Morgan Stanley may also own property such as the tanks themselves, due to their history as investment banks. In a surprise move, the Fed announced it might revoke these approvals. Then, citing potential new rules, JPMorgan revealed it may sell its physical commodities business.

At a Senate hearing on Tuesday, where witnesses gave a long list of reasons why banks should not hold commodities. Most of these were dubious.

A law professor warned of a situation where “the same institutions that control the flow of credit throughout the economy also control the flow of raw materials”.

Hardly. Look at crude oil: JPMorgan, the top importer among the banks, last year delivered 46.8m barrels of foreign crude to the US. This was 1.5 per cent of the national total, energy department records show. ExxonMobil imported 393.7m barrels. In wholesale electricity JPMorgan’s US market share is 3 per cent, according to Platts.

This is not to say a bank cannot influence prices. Queues to obtain metal at London Metal Exchange warehouses owned by Goldman and others have pushed up premiums for physical aluminium over nearby futures contracts.

“Aluminium prices have become inflated,” MillerCoors testified at the hearing. But the brewer was being clever. Premiums are relative values. They widen when physical prices rise; they also widen when LME futures prices fall. Even including the premium, aluminium prices have declined in the past few years.

In any case, queues are not unique to banks: they also exist at warehouses owned by traders such as Glencore and Trafigura. The problem lies in lax oversight and the fact that exchanges are natural monopolies. Once a futures contract such as LME’s becomes the benchmark, it is almost impossible to dislodge. Comex, a New York exchange, tried for a decade before delisting aluminium futures in 2008.

Senator Elizabeth Warren said the banks had adopted a “business model pioneered by Enron”, the infamous failed energy merchant. That is true in as much as they fuse finance and commodities trading. But she ignores history.

In 2000, banks including Morgan Stanley and Goldman backed IntercontinentalExchange as a challenge to Enron’s electricity trading platform. When financial markets froze in 2008, ICE’s model of sending energy swaps to a clearing house became a template for derivatives reforms.

Now the warehouse controversy and allegations of power market mischief by Barclays and JPMorgan seem to have turned regulators’ attention to the broader question of banks in physical commodities overall. “JPMorgan, Barclays and Goldman have brought down this rain of hell,” a veteran Wall Street commodities executive laments.

For Craig Pirrong, author of the bank-commissioned study on commodity trading houses, this is karmic justice. The banks buried his report after he concluded traders pose less systemic risks than big banks. “They should have paid more attention to making the affirmative case for their own activities in these markets,” he says.

Forcing banks out of commodities will not make warehouse queues disappear or power markets free of manipulation, however. It does mean the dominant market participants will be low-profile companies far less sensitive to public criticism. That is not necessarily an improvement.

JPMorgan To Exit Physical Commodity Business

Tyler Durden on 07/26/2013 15:18 -0400

After weeks of emptying of their Gold vaults and making headlines in recent days over their oligolopolization of commodity warehousing, it seemsthe threat of a probe has excited Blythe and her colleagues to dump while the dumping is good:


Options include sale, spin-off, or strategic partnership as they re-confirm that they are “fully committed to traditional banking activities,”as they look to drop the holdings of commodities assets and the physical trading business. We can only assume that “physical commodities” include the company’s extensive inventories of tungsten (as well as the vault housing it), and not so extensive stores of gold and silver. That said, we are confident that the collapse in represented (but not warranted) JPM Comex gold vault holdings to a record low, and this news is completely unrelated.

From JPM:

J.P. Morgan to Explore Strategic Alternatives for its Physical Commodities Business

New York, July 26, 2013 – JPMorgan Chase & Co. (NYSE: JPM) announced today that it has concluded an internal review and is pursuing strategic alternatives for its physical commodities business, including its remaining holdings of commodities assets and its physical trading operations.

To maximize value, the firm will explore a full range of options over time including, but not limited to: a sale, spin off or strategic partnership of its physical commodities business. During the process, the firm will continue to run its physical commodities business as a going concern and fully support ongoing client activities.

J.P. Morgan has built a leading commodities franchise in recent years, achieving a top-ranked revenue position. The business has been consistently named as a top client business in Greenwich Associates’ annual client surveys and was recently named Derivatives House of the Year by Energy Risk magazine.

Following the internal review, J.P. Morgan has also reaffirmed that it will remain fully committed to its traditional banking activities in the commodity markets, including financial derivatives and the vaulting and trading of precious metals. The firm will continue to make markets, provide liquidity and offer advice to global companies and institutions that have, for years, relied on J.P. Morgan’s global risk management expertise.

And then the question: which Fed-backed bank will “buy” JPM’s commodity exposure? Or maybe this time Bernanke will cut away the middlemen and make the tunnel between its gold vault and that of JPM across Liberty Street, official?

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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