Mercuria Energy Group Market Cap (as of 21/03/14): N/A
J.P. Morgan Chase & Co. Market Cap (as of 21/03/14): $225.98bn
On the 19th of March, J.P. Morgan announced that it has reached an agreement to sell its physical commodities business to Mercuria, the fourth-largest independent commodity trader. Mercuria beats offers from Blackstone Group and Macquarie Group, setting the deal at $3.5bn, which is expected to be closed in the third quarter of 2014.
The bulk of the purchase price is represented by the bank’s physical commodity inventory, including crude oil and base materials. J.P. Morgan’s physical commodity business used to represent one of the most powerful oil and metals desk on Wall Street. By selling it, the bank is ending a five-year period of owning and storing raw materials. The period began with the acquisition of Bear Stearns in 2008, which included an energy-trading platform. Moreover, the bank bought UBS AG and Canadian commodities units in 2009 and part of commodities trader RBS Sempra in 2010, which brought J.P. Morgan the Henry Bath unit.
Even though the bank is selling the unit, it will continue to provide services and products tied to commodities, including financing, market making and vaulting and trading of precious metals. In this all cash transaction, Mercuria is acquiring a business that has assets of $3.3bn and that generates $750mm in annual operating profit before compensation costs.
Mercuria, which started with a focus on oil trading, was founded by two former Goldman Sachs commodity traders, Marco Dunand and Daniel Jaeggi. The Swiss trading house managed to expand its non-oil business in the past 18 months to include metals, gas, power and agricultural products and managed to double its revenue in 2013 from 2012 to $100bn. With this deal, Mercuria will boost its presence in the North American power and gas markets and will get Henry Bath & Sons, the 220-year-old metal-warehouse operator that is based in Liverpool. Despite the deal will not put Mercuria in the same league as the industry giants like Glencore Xstrata, Trafigura Beheer and Vitol, it helps to elevate further the company’s profile. Mercuria has grown very fast and in the past 10 years has seen the number of its employees growing from 10 to 1200, and other 600 could join from the acquired division.
From a wider perspective, this sale is another step remarking the reversal from a trend toward greater involvement of financial institutions in commodity markets. During the past ten years, banks have not only assisted clients but also traded for their own accounts. In this context, buying physical assets (such as storage tanks) was a necessity for investment banks in order to gain the flexibility to accept delivery of and hold on to commodities such as oil, sugar, corn and metals.
Nowadays this business model was no more sustainable due, mainly, to new capital requirements and political and regulatory pressure. In fact, the rise in capital requirements under the Basel III framework and the restrictions on proprietary trading have made commodity markets less attractive for many banks, especially with regards to more volatile markets such as electricity. According to a British consultant, commodity income at the world’s top 10 investment banks has dramatically fallen from more than $14bn in 2008 to just $5.5bn in 2012.
On the regulatory side, not only Fed has made clear that was reviewing a decade-old decision that allowed lenders into the business because physical commodities were “complementary” to banking, but also growing pressures have emerged to clamp down on banks’ ownership of metals warehouses, oil pipelines and other commodity assets. On top of this, J.P. Morgan had to pay $410mm last year to settle charges of manipulating California electricity markets.
For all those reasons the decision came as little surprise. Deutsche Bank had already announced late last year that it was largely exiting commodities trading, and Morgan Stanley sold the majority of its global physical oil trading operation to Russia’s Rosneft. It is clear that, over the past two years, private and lightly regulated trading houses have benefited a lot from this retreat by banks from commodities trading. Nonetheless, this deal is peculiar in the sense that Mercuria will become the first trading house to absorb an entire physical division from a bank. Only time will show if this is just the first step for Mercuria to be among the giants of the commodities firms.