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Banks Ramp Up Oil Trading: What Could Go Wrong?

18 July 2012 in Trading Ideas

After a less-than-brilliant performance during the recent financial crisis, one could forgive investors for looking a bit skeptically at news that Wall Street investment banks are stepping up activity in the global oil markets.

Specifically, as the Financial Times recently reported, these banks – JPMorgan Chase (JPM), Morgan Stanley (MS), and Goldman Sachs (GS) – have struck deals to supply US refiners. The Times says that Goldman Sachs is now the largest supplier of crude and the largest customer of refined products of refiners owned by Alon (ALJ) in California, Louisiana and Texas.

Why the new business for the banks? As it turns out, the recent elevated price of oil, which saw crude trade above $95 a barrel for about six months from November 2011 to May 2012, forced cash-strapped independent refiners to turn to banks to finance their oil stocks.

As Blythe Masters, global commodities head at JPMorgan told the FT, “Banks are not competitors of [the refiners] but rather facilitators for them. That, along with risk capacity and balance-sheet capacity, is the reason why banks play a role.”

As the FT noted, the increased role by banks in oil supply comes as US regulators work toward implementing new rules that limit the size of oil derivatives positions held by financial traders. But, the FT says, banks can use physical oil supplies to “offset against their quota of derivative positions.”

And here’s the kicker: Morgan Stanley and JPMorgan are lobbying regulators to exclude “forward” commodity contracts for future delivery of stock from the Volcker Rule, a part of the Frank-Dodd financial reform law that is set to go into effect at week’s end. In a letter in February, Morgan Stanley warned that restricting banks’ ability to compete in commodities would force customers to turn to “trading houses, energy merchant companies, oil companies with trading desks, or other types of traders.”

Trust us instead, the banks seem to be saying. Investors may feel they’ve had similar requests in the past.