Price boom draws more banks deeper into energy

High oil prices and booming commodity markets have started a new goldrush into the sector that will see more banks chartering tankers and renting oil storage facilities. Morgan Stanley and Goldman Sachs have dominated in energy and commodities for more than two decades and were even known as Wall Street refiners.
The newcomers such as Lehman Brothers and Bear Stearns are eager for a share of global revenues from this sector that reached an estimated $11 billion last year, up from around $7 billion in 2005, according to estimates included in a Credit Suisse research report.
They want to capitalise on a surge in demand for products to hedge volatile commodity prices, or to gain exposure to energy or other commodities as an investment. Firms have tried before to gear up in this area, but many preferred to trade financially rather than physically.
This time may be different as several new players are preparing to enter the physical trade in crude oil and many already trade gas.
"Higher volatility has generated more hedging needs from banks' traditional customers as well as more arbitrage opportunities for those engaged in arbitrage trading strategies," said Amine Bel Hadj Soulami, global head of commodity derivatives at BNP Parbas.
"And being active in the physical market helps you better understand the dynamics of the market - what is driving supply and demand." Morgan Stanley has long been active in the physical markets in energy. The US bank has, for example, 45 ships on charter and numerous storage locations in north west Europe. It owns power stations in Europe and the United States.
The bank also bought Heidmar, a US shipping firm, last year and also Transmontaigne, a transport company. "We wanted to participate in the physical markets in commodities to be better able to hedge," said Colin Bryce, who heads commodities at the bank.
"If you are in the physical markets you can also spot trends in advance of the futures markets." Barclays moved into the commodities and energy arena a few years ago and is now about to start physical crude oil trading.
BNP Paribas has long-standing specialist commodities and energy related businesses.
But now a new wave of banks, including Bear Stearns, Lehman Brothers, UBS, Citigroup and J. P Morgan are ramping up in Europe. "You really have a very wide diversity of commodity investors," said Etienne Amic, who has just moved to Bear Stearns from French bank Calyon to head its new European energy business.
"You have private investors investing in commodity structured notes, you've got financial sponsors buying all sorts of infrastructure assets from power plants to distribution grids."
There are big hurdles to getting into the physical side of energy, including huge costs and also environmental liabilities. For this reason some new entrants may opt for a purely financial approach.
"Most banks and hedge funds prefer financial markets since physical transactions require additional staff to co-ordinate logistics and introduce force majeure risk and operational risks," said Keith Holst, head of European power and gas trading at UBS. Another issue is finding the staff. "There is a shortage of experienced people," said Bryce from Morgan Stanley.
Britain's financial watchdog has already upped its scrutiny of banks' burgeoning activities in commodities and energy, warning that lack of skilled people is a concern.
Hedge funds, a big revenue-earner for investment banks, are also expanding in this arena. Last year, for example, hedge funds accounted for $2.1 billion of the estimated $10.7 billion in global investment banking revenues from commodities in 2006, according to estimates in a Credit Suisse research report.
"The question is will people be here to stay this time or pull out as some did in the past," said Frank Feenstra, a managing director of consultants Greenwich Associates. "This time the investor population is much bigger which might help in the case of a downturn in the market."