U.S. gas, power producers return to hedging after wild price swings - Citi

Wed Jul 2, 2014 12:10pm EDT

* Some producers have not hedged for years - Citi

* In Europe refining hedging remain depressed, except capital solutions

* Citi says slightly scaled back own commodities trading unit

By Dmitry Zhdannikov

LONDON, July 2 (Reuters) - Sharp volatility in U.S. gas and power markets over the past winter due to extreme weather has prompted some producers to return to price hedging after being absent from the market for years, Citibank said on Wednesday.

Commodities producers and consumers tend to hedge forward prices during periods of sharp volatility and reduce activity when prices are stable, which means less revenue for banks who are the main providers of hedging services alongside big oil companies or power traders.

"You had producers who didn't really want to lock in a very low forward curve," Citi's global head of commodities, Stuart Staley, told reporters, referring to several years of depressed U.S. natural gas prices due to the shale boom.

"But the volatility that was introduced to that market and the higher prices that resulted from the extreme weather conditions have brought back some of the gas and power client activity that we haven't seen for some years. And that has been a big contributor," he said.

Gas prices spiked in 2013/2014 because of an exceptionally long and cold winter in most of the United States. A repeat of that is likely, as scientists predict volatile long-term weather patterns and as the share of gas in the U.S. energy sector rises.

Staley said that Citi did two landmark deals over the past year, becoming a physical offtaker of power to be produced by two U.S. utilities - thus providing a hedge for several years of forward production. He did not name the producers.

Citi has been expanding in commodities in the past years after having cut exposure during the 2008 financial crisis.

The latest expansion went counter-cyclically to the moves by Deutsche Bank, Barclays, Morgan Stanley and JP Morgan which have all reduced or cut exposure under regulatory pressure, leaving only Goldman Sachs relatively unhurt.

Staley said Citi faced the same pressures as other players and has also reduced staff to 250-260 people in commodities trading from the peak of 320 last year.

It saw revenues rising 220 percent last year from a "low base" in 2012 and this year already looked better than last thanks to a good performance of the power and gas divisions.

EUROPEAN OIL REFINING

In Europe, the bank is discussing capital solution deals for oil refiners, when the lender holds oil and petroleum product inventories on behalf of the plant.

Such deals allow refiners to alleviate the burden on working capital and reduce price-volatility risks at a time of poor refining margins.

Barclays was among the most active provider of such services until it decided to scale back its commodities division earlier this year.

"The landscape has changed a lot because it is driven by the lack of volatility rather than anything else and a lack of credit," said Staley.

Providing capital solutions to refiners is allowing banks in Europe to maintain some meaningful hedging activity as demand for other services from refiners has shrunk.

"There is no need to hedge oil in storage or to play some contango plays. Forward margins are backwardated and spot margins are extremely weak and as a refiner there is little need to lock those in," said Staley.

Higher forward prices encourage refiners to store oil but as the market has faced an opposite structure for some years, known as backwardation, refiners have kept oil storage to a minimum. (Editing by William Hardy)

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