FROSTY WINTER BENEFITS
Goldman Sachs and Morgan Stanley both cited stronger commodities trading as a bright spot in the first quarter, aided in part by extraordinary volatility caused by the coldest U.S. winter in three decades.
The two longest-serving banks in the sector took on more risk in the quarter, and may be benefiting from rivals scaling back or quitting the raw materials trading business due to new capital and trading regulations and slimming profit margins, underscoring the benefits of sticking out a tough patch.
"The firms that are announcing exits from commodities, for example, they weren't in those businesses in the 1990s," Goldman Chief Financial Officer Harvey Schwartz said. "We got into commodities in 1981."
Morgan Stanley, which is selling its physical oil trading arm to Russia's Rosneft but will retain its large power and natural gas desks, said a "strong performance" in commodities helped boost its wider Fixed Income and Commodities (FICC) net revenue to $1.7 billion from $1.5 billion.
"We had real strength in commodities, given volatility in the market driven by weather, and we had a real robust client activity," Morgan's Chief Financial Officer Ruth Porat told Reuters. She said commodities revenues would still have been "slightly" higher excluding physical oil trading.
Goldman, which has said it has no intention of backing away from the J Aron franchise it bought three decades ago, said "significantly higher" net revenue in natural resources trading compared with early 2013 had helped offset lower returns across the rest of FICC.
Asked whether energy markets were the main driver, Schwartz said: "That's where the primary volatility was."
The banks offered no further details, but market sources said they appeared to be among the biggest trading beneficiaries of the deep freeze that swept much of North America this winter, triggering the greatest price volatility in years for many regional fuel, electricity and natural gas markets.
Aided by sophisticated models that process weather data in seconds, one popular spread trade was buying U.S. natural gas and selling in Europe, which enjoyed the warmest winter on record, trading sources said.
They may have also benefited by holding fuel or natural gas in storage, releasing it to meet surges in demand. For instance, physical natural gas prices at the primary New York Transco hub in mid-January surged more than 20-fold to $120 per million British thermal units in one day.
"The liquids side of it was getting to be very seriously constrained because of the cold snap ... if you have the storage and the inventory on hand, you clearly benefited from that," said Patrick Reames, Managing Partner and Commodity Technology Advisory, in Sugar Land, Texas.
The banks do not provide any financial information about their commodity trading, but analysts reckon that Goldman and Morgan likely contributed around a third of the overall industry's estimated $4.5 billion in revenues last year.
The banks were not alone in benefiting from the gyrations, which appeared to cast winners and losers regardless of their place in the market.
The harsh weather delivered a series of unexpected jolts, including an unprecedented shortage of propane in the Midwest that caused prices to treble, a surge in ethanol prices to more than gasoline due to slower rail deliveries and an unusual turn by some East Coast generators to burn oil for power.
One large utility operator in the U.S. Northeast was able to sell some excess natural gas to power generators at huge profits on the coldest days of the winter when prices in New York averaged over $30 per mmBtu, a source familiar with the trades said. Michigan-based utility DTE Energy (DTE.N) said it lost $3 million on energy trading in the last quarter of 2013.
Cargill, one of the world's largest commodity traders, said its quarterly earnings fell 28 percent due to several market disruptions, including a trading loss in power markets that one industry publication put at over $100 million.
While there has been no suggestion that big traders may have exacerbated the price spikes, adding to rising consumer energy costs, the strong results come at a delicate time for Wall Street's powerhouses as they seek to fend off tougher rules that could curtail their physical trading operations.
The Federal Reserve is now reviewing public comments on whether it should push back banks' decade-long expansion into the raw materials supply chain over fears such risky trading could endanger the financial system - or that it might allow Wall Street too much sway over commodity prices.
The upbeat revenue figures also offered signs of hope for a business line that's been under intensifying margin pressure in recent years due to restrictions on trading with banks' own money, rising capital requirements, and signs the so-called commodities super cycle may have peaked.
Thursday's results may also illustrate how Goldman and Morgan Stanley are benefiting from rivals exiting or scaling back in the sector, including one-time top five firms like JPMorgan and Deutsche Bank.
"Right now it feels like we're starting to maybe see the beginnings of some marginal benefit of competitors exiting parts of our business that otherwise quite frankly they had charged in with excess," Schwartz said.
The top 10 banks in commodities made $4.5 billion from natural resources trading in 2013, a report from UK analytics firm Coalition showed earlier this year.
While significantly below the near $14 billion made by banks in commodities in 2008, it still represents a sizeable chunk of Wall Street's overall earnings.
Both Goldman and Morgan Stanley reported an increase in commodities exposure known as Value-at-Risk (VaR) from the last quarter, with Goldman raising its VaR to $21 million, the highest in a year.
Morgan Stanley increased its commodity VaR to $20 million from $18 million, despite preparing to sell its merchant oil trading business to Russian energy major Rosneft.
Goldman's overall FICC revenue fell 11 percent to $2.85 billion from the same period last year.
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