For decades, two names have dominated the $4 trillion world of commodity and energy derivatives trading: Goldman Sachs and Morgan Stanley. If Wall Street power woman Blythe Masters has her way, a third will soon be making it a troika: JP Morgan.
The former credit derivatives wunderkind who has built JP Morgan’s commodities business into a true global powerhouse in just three years is on the cusp of buying RBS Sempra Commodities for an estimated $4 billion, bringing an unusual but highly successful hybrid trading operation —one that carefully mixes customer-flow business with prop-trading risk — under the well-capitalised JP Morgan umbrella.
The spoils appear to suit JP Morgan to a T. One of the three biggest US gas and power trading desks, a unit that not only survived but thrived through the darkest Enron days to generate about two-thirds of RBS Sempra’s profits; it adds a Connecticut-based, fund-like complement to the more customer-oriented Houston gas trading team she inherited with the Bear Stearns acquisition in 2008.
The biggest and one of the most successful physical base metals trading and broking shops ever, the London-based enterprise that was once Metallgesellschaft, including the massive worldwide warehousing company Henry Bath, addressing one of the bank’s weakest spots.
And a global oil team with a decade of experience trading physical crude oil cargoes and diesel barges, markets in which JP Morgan has only begun to dabble.
It would be a career-crowning coup for British-born Masters, at 40 one of the most successful women on Wall Street and famed as one of the original creators of credit default swaps in the 1990s.
It would add RBS Sempra’s over 1,000 traders, marketers and operators to her 500-person operation, which by last year had already eclipsed Morgan Stanley’s commodities division in terms of personnel, industry sources say.
But the victory could yet prove a hollow one at a time when US futures regulators are moving to limit big energy positions and US President Barack Obama has moved to ban banks from proprietary trading, last week’s broadside against the sector that could yet shade the deal.
Setting aside the policy risks, Masters must win the loyalty of traders who helped the company notch up 32 consecutive quarters of profits from 1997, earning Sempra Energy nearly $3 billion over 12 years, but who are now increasingly disappointed or disillusioned with working for a bank, multiple sources close to the company and its traders have told Reuters.
Although both operations are built largely around selling or buying directly with customers, a type of trade that would be excluded from Obama’s as-yet vague crack down, JP Morgan still wagers more than $30 million a day of its own money on commodity markets, more than Morgan Stanley, and RBS Sempra’s Value at Risk has expanded since RBS bought in, data show.
“They could make the mistake of forgetting they’ve got real rainmakers on the desk, not pay them well, and watch them take off,” says industry consultant John D’Agostino, a former NYMEX official and energy hedge fund manager.
Masters will have to woo them without the aid of the four partners who built the RBS Sempra business over nearly three decades, from its early inception at Drexel Burnham Lambert and AIG through its sale to the UK government-owned bank last year, all of whom have departed in the past two years; a number of traders have followed.
And she’ll have to integrate Sempra’s disparate units — power and gas in Stamford, Connecticut; metals in London; oil with a strong base in Geneva—which have always operated with relative autonomy. While they had a “Wall Street style of trading”, as Sempra Energy’s Chief Financial Officer Mark Snell said in 2007, it wasn’t a Wall Street style of management.
“Having hired people out of Sempra during RBS, what unanimously they say is that what made Sempra special is how things were done— the process, direct access to management. Within a bank, what you have is a completely different process,” said one senior trader at a competing company, who asked not to be identified.
“They’ve not only lost management, they lost a lot of traders. The question is: did they build a big enough infrastructure that traders are less key?”
The deal pairs the most aggressive up-and-comer in the commodities sphere with a relatively mature franchise, one that made its name with some big bets on China, clever recruiting and an uncanny knack of building on the back of failure.
Masters, a Cambridge-educated derivatives expert and avid amateur horse rider, was drafted into commodities from the Chief Financial Officer role in early 2007 after JP Morgan’s first major foray into energy markets went awry.
Having assembled a team of heavy hitters in the natural gas market around 2005, the bank had been on a risk-taking roller-coaster, with its commodities VaR surging to a one-day peak of $128 million in 2006, more than treble the year’s max for its foreign exchange trading, according to SEC filings.
After some key staff changes, she expanded both organically and opportunistically, snapping up UBS’s global agricultural markets and Canadian commodities businesses in late 2008, as well as broker MF Global’s sugar book, quickly making up for the bank’s relatively late start in a booming sector where the likes of Barclays Capital and Deutsche Bank had been building up their desks since early this decade.
Sempra, by contrast, has much deeper origins. In early 1990, an aggressive insurer called AIG decided to start an energy trading operation by snatching up 150 of the best traders from the large physical energy business of the once-powerful brokerage holding company Drexel Burnham Lambert, which had filed for bankruptcy.
It was there that David Messer and Frank Gallipoli, widely seen as the strategic visionaries of the company, began to plot their rise, together with a band of traders, some of whom had been together since 1982.
Two others were instrumental: Steven Prince, a Drexel alum who kept things running smoothly as the main front man and back-office wizard; and Todd Esse, who joined in 1994 as the rainmaker natural gas trader whose earnings were said to have been used as the main metric for valuing the company when Sempra bought it in 1997 for $225 million.
At the time, Enova Corporation and Pacific Enterprises (PE) were joining forces to become a mighty southern California power utility, but executives saw the need to be more than passive price-takers -- to prosper, they would need to better understand the markets for oil and gas, the fuels that fired their plants and global economies.
They also saw an opportunity to juice up profits from an otherwise dull, heavily regulated utility business, and eagerly fostered the development of the disparate group.
“David and I used to travel around the country trying to convince people to do business with us. And at that point in time, we were making no money at all, and David Messer would never shine his shoes,” Donald Felsinger, Sempra Energy’s chief executive, told a conference call last March.
“The soles had holes in the bottom of them. And I can remember telling David, you know, we have to look like we’re making money, so, fix it.”
It’s a familiar refrain for a scrappy company that was consistently more agile than most of its peers.
So eager was it to get its European energy desk off the ground in early 1999 that Sempra’s first offices were in a disaster recovery site rented above the famed Club Aquarium in London’s Old Street, where business practically came to a halt after 6pm as the bass track drowned out conversation.
In 2002, they picked up the metals division from a failing Enron for just $145 million, including veteran traders who had built the Metallgesellschaft franchise in the 1990s into the biggest London Metals Exchange ring dealer; Enron had bought the UK-listed MG two years earlier for $448 million.
“They were good at identifying talent, then good at giving people a free hand. They weren’t trying to second-guess you,” says Daniel Jaeggi, a former Sempra oil trader who was poached from Phibro in 1998 to set up its first oil desk.
He and long-time collaborator Marco Dunand left in 2004 to help found Mercuria, now a top five independent oil trading house.
Some of their most notable moments revolve around China.
In February 2002, the small Geneva-based crude oil trading team nearly cornered the market in benchmark Brent crude in what was seen as a highly successful if controversial trading play; halfway through the month, the mystery of what they would do with the oil was revealed as a flotilla of tankers were chartered to China, where they had agreed on a massive sale.
It was not always so fortuitous. In 2005, a rogue trader for China’s State Reserves Bureau ran up massive losses on what was said to be an unauthorized short position on copper; Sempra was the biggest broker in the deal, the China Securities Journal reported.
That same year Sempra’s metals division suffered a nearly three-quarters collapse in its trading margin, according to SEC filings. Despite sometimes mixed results, Sempra’s traders logged an all-but unparalleled decade of consecutive quarterly profits. Ultimately, the unit became a victim of its own success.
By 2005, Sempra Commodities contributed more than half the parent company’s net income of $920 million; it made over half a billion dollars in 2007.
Its trading margin had trebled to over $1.5 billion in just five years, with two-thirds of that in natural gas and power, nearly a fifth in metals and 12 percent in oil, according to SEC filings for the last year it operated solely under Sempra. Three-quarters of its margin was still generated in the United States.
Not only was it consuming ever-increasing amounts of capital as commodity prices exploded, its volatile and increasingly large earnings component was a frustrating sell to shareholders, many of whom still thought they were investing in a conservative, dependable utility company.
The sale to RBS allowed Sempra to keep 49 percent of the earnings while relieving itself of much of the capital burden. JP Morgan is unlikely to want to share the spoils.
By most accounts, Masters won’t have much of a battle for leadership.
Todd Esse, whose star never shined quite as brightly after his relocation to set up the moribund London gas and power unit in the late 1990s, left to start a Connecticut-based hedge fund in 2008. Steven Prince’s retirement had been announced at the time of the RBS acquisition.
Gallipoli left nearly a year later. Messer, a well-known art collector with a predilection for controversial BritArt, was the last to leave, with a note saying, in effect, “gone fishing”. Both were said to have been put off by the prospect of curtailed pay packages at a bank-run operation.
Michael Hutchinson, a Metallgesellschaft veteran and towering figure in the tight-knit London metals market for four decades, also stepped down last year.
Relative newcomers now mind the shop. Kaushik Amin, a 14-year Lehman Brothers alum and Cornell PhD, was hired last May as CEO.
Other Lehman refugees also joined the energy side, trade sources say. The metals business is run by Peter Sellars, who joined in 2002 after nearly a decade at Barclays.
Fundamentally, Masters’ biggest task may be altering the perception that it’s the wrong time and the wrong place to be a big trader at a big bank.
“We’ve seen talent leaving,” said one source familiar with the company. “With bonuses getting attacked and what’s happening in the broader picture, the banking sector has become a less attractive place to work.”