By David Wells –
Passengers on United Airlines flight 904 from Los Angeles to New York this morning have Morgan Stanley to thank for keeping them aloft.
The investment bank provides UAL Corporation, United’s parent, with all its jet fuel at 35 airports as well as financing all third-party fuel sales and handling UAL’s fuel trades.
This arrangement, agreed in late 2003, will run for three years and represents a good deal for both parties: UAL’s 2002 fuel bill was $2.8bn and the bankrupt airline estimated the deal would save $5m a year.
But what does a financial services company know about jet fuel? Plenty, apparently.
Morgan Stanley started in the commodities business in 1982, trading metals. It began energy trading in 1984. Its 200-strong commodities team, led by Neal Shear and John Shapiro, is understood to generate about $1bn in revenue a year. Its second quarter of 2004 was the second best on record.
The performance did not go unnoticed. Goldman Sachs, Morgan Stanley’s biggest Wall Street competitor in commodities sales and trading, has also done well. But many others, including Merrill Lynch and Credit Suisse First Boston, have either quit commodities or let their divisions wither.
That may be changing. When Merrill Lynch reported its second-quarter earnings, Ahmass Fakahany, chief financial officer, said the investment bank would increase its commodities business.
In May, CSFB formed a joint energy-trading venture with TXU, a Texas utility. Other rivals, including Citigroup and Barclays, are also building up their commodities businesses.
It has been a good year for trading commodities. Oil has surged to more than $46 a barrel from about $32.50 at the end of 2003. Natural gas, soyabeans, steel, coal and other products have also been volatile, as has orange juice following Hurricane Charley in Florida.
But for those looking to get into the business, the road will be tough and expensive, given the cost of acquiring people, and increasingly assets. This makes investors nervous because, when it comes to commodities, Wall Street is fickle.
Merrill Lynch has been in and out of the business several times. Lehman Brothers built what looked like a potentially strong competitor but then cut off the business to expand other areas of business.
Whether the current interest in commodities will prove lasting remains to be seen, but banks are making big commitments. CSFB’s joint venture, slated for an October start, will market and trade power, natural gas and other energy-related commodities in North America.
The partnership is meant to combine CSFB’s energy banking franchise, the investment bank’s credit strength (trading requires excellent credit), transaction structuring skills, and a distribution network with TXU’s energy expertise, power plants and transaction volume.
John Healy, co-head of fixed income at CSFB, says commodities offer “tremendous potential”. He hopes the TXU venture will help CSFB to expand a number of its existing businesses.
He says: “Our investment with TXU combines CSFB’s investment banking, structuring and trading expertise with TXU’s energy assets and significant transaction volume, and that’s a powerful combination that will benefit both companies.”
Merrill Lynch or another rival might have a similar chance of a joint venture.
When Entergy, another energy company, reported second-quarter earnings on August 2, it said it had decided to sell Entergy-Koch, an energy-trading venture with Koch Industries.
Several suitors have emerged, and “advanced negotiations are under way with one party”, the company says.
Some of these transactions have worked. Sempra Energy Trading, the child of of one such union, is admired by many traders. Others have not been so lucky.
UBS made a bet that it was the perfect group to fill a void in trading left by Enron, and snatched up part of the energy trader’s business. But the bank has since admitted that, while profitable, the operation has not delivered on its potential.
Morgan Stanley and Goldman Sachs had the luxury of building their commodity franchises over decades. Rivals to the investment banks wonder if those returning to commodities, especially energy, are willing to stick with the business this time.
John Kilduff, of Fimat USA brokerage, says: “We all welcome the liquidity. They are formidable organisations.”
However, he cannot help wondering whether all the interest makes it seem that the market is hitting its peak.