Fed turns sour on banks’ physical commodities trading; Any restrictions on banks’ activities would benefit energy companies

January 16, 2014 8:52 am

Fed turns sour on banks’ physical commodities trading

By Gregory Meyer in New York

Any restrictions on banks’ activities would benefit energy companies

Asurprise outcome of the Deepwater Horizon disaster may be to eliminate competition for BP’s formidable energy trading business.The 2010 explosion and spill at a BP oil well in the Gulf of Mexico was invoked repeatedly as the Federal Reserve this week invited comment on whether to continueallowing banks to handle physical commodities such as oil and natural gas.

The Fed has given 12 bank holding companies such asCitigroup and JPMorgan Chase increasing latitude to trade physical commodities over the past decade. It is now having second thoughts, as outlined in a 19-pageadvance notice of proposed rulemaking.

The costs of BP’s offshore spill are referenced as evidence the Fed may have underestimated the risks of handling commodities. Past Fed approvals required banks to use oil tankers sanctioned “by a major international oil company” – a safeguard that now looks dubious.

“The oil spill involving the Deepwater Horizon drilling unit suggests that current industry safety policies and procedures may not prevent a major environmental disaster and may call into question the effectiveness of such procedures,” the Fed said.

Keeping finance separate from commerce is a bedrock principle of US banking law. But since 2003, the Fed has allowed banks to hold commodities if the business was “complementary” to finance.

The rationale was that banks “would not be disadvantaged by market developments if commercial activities evolve into financial activities or non-bank competitors find innovative ways to combine financial and non-financial activities,” this week’s notice said.

The Fed now sees the fact that some banks, including JPMorgan and Deutsche Bank, are shrinking their commodities businesses as a sign it may have been mistaken: “The developments may indicate that Complementary Commodities Activities are not necessary to ensure competitive equity between [banks] and competitors.”

If banks are forced out of the physical market, energy companies and trading houses will be beneficiaries. For an example of how they already compete, look at the US east coast refinery hub along the Delaware river.

There, BP has a three-year agreement to supply crude oil to Delta Air Lines’ refinery in Trainer, Pennsylvania. Just up river, JPMorgan supplies crude to and buys fuel from the Philadelphia Energy Solutions refinery.

Nearby, Goldman Sachs buys and sells petroleum products refined by PBF Energy in Paulsboro, New Jersey and Delaware City, Delaware, according to a securities filing. As of September, Goldman owned 3.2m barrels of inventory – an amount that exceeds one day’s east coast petrol demand.

To rub things in, BP is encroaching on Wall Street’s patch: financial derivatives. The oil group last year registered as a swap dealer with regulators.

“We didn’t want to go back to just being a physical supplier,” Orlando Alvarez, president of BP Energy Company, told Energy Risk. “That’s not what we’ve done for the last 10 years. We have been a physical supplier and offered risk management services as well.”

After the Fed’s commodities review became public last year, a US banking lobby commissioned a study that said financial institutions were “essential” to commodities markets and cited banks’ services to Delaware river refineries.

But there is little panic in the Delaware valley. “The market is a pretty creative and elastic space, so I think that if the banks get out of the market, somebody else is going to take their place,” Philip Rinaldi, chief executive of Philadelphia Energy Solutions, told me this week.

For BP and other energy companies, that sounds like opportunity knocking.