By Jonathan Leff
NEW YORK, Feb 19 (Reuters) - An investor bid to break up Hess Corp's sprawling energy empire has drawn unwelcome attention to one of the commodity trading world's lesser-known players, a venture that has stumbled in recent years after a decade of success.
Hess Energy Trading Company, the New York-based joint venture known commonly as Hetco, is one of a handful of Hess Corp units unrelated to the production of oil and gas that activist shareholder Elliott Management says should be "reassessed," advocating the firm's split-up.
While Hetco is only a tiny piece of the Hess puzzle, it could prove problematic to spin out, despite the Goldman Sachs pedigree of founders Stephen Hendel, 61, and Stephen Semlitz, 60, long-time collaborators known as "the two Steves." They each own 25 percent of the company, while Hess Corp owns the other 50 percent, an unusual arrangement.
One problem: Investor demand for exposure to the commodity trading industry, hot in recent years, may be waning. Those with the means to finance the business is also diminishing.
From the public listing of industry heavyweight Glencore in 2011 to the private equity buy-in to Louis Dreyfus-Highbridge last summer, a flurry of deal-making has already transformed the once little-noticed sector. The near 30 percent slide in Glencore's share price since its float two years ago also speaks to diminishing expectations.
Wall Street banks, once the obvious candidates for buying their way into the industry, are in retreat, shedding staff like Deutsche Bank or even looking to hive off their operations like Morgan Stanley.
Hetco's recent results may vex as well: After a decade-long streak of modest profitability after its founding in 1997, Hess Corp's trading activities - which it says are largely confined to the Hetco unit - have become a drag on earnings, according to company filings. In the UK, Hetco has lost money in three of the past four years, previously unreported filings show.
One major unknown: How much of Hetco's business is dependent on its links with Hess, which provides unassailable credit? (According to Hetco's own websites, it is "fully guaranteed" by Hess Corp.)
"It can be almost impossibly hard to value these things," said one senior industry executive. "But one thing is for sure - it would be hard to get a similar deal today, splitting the profits 50-50 while Hess provides the balance sheet."
While the likes of Glencore, Mercuria and others appear regularly in the media as they seek to enhance their profiles or prestige or raise capital, the Steves have never spoken publicly about their business. Through spokespeople and senior Hetco employees, they have declined repeated requests for interviews.
Hendel's only major appearance in print was in a 2010 New York Times profile focused on his unlikely role as a major producer - together with his wife - of the Broadway musical "Fela," based on the music of an Afrobeat artist.
In its prospectus for reassessing Hess Corp, Elliott terms Hetco a "hedge fund," which isn't quite correct.
Hetco doesn't collect fees or bonuses for managing outside investor money. Nor does it restrict itself to trading in the most liquid futures markets, as most funds do. (It does, however, dabble in some equities trading, sources say.)
Instead, an estimated 100-plus Hetco traders in seven offices from New York to London to Singapore generally focus on profiting from price discrepancies and trading gaps in the physical market for crude oil, refined fuels and natural gas, using fundamental analysis to spot arbitrage opportunities and big trades, according to industry executives who know the company and have traded with it for years.
Yet like many of its peers, Hetco has also engaged at times in traditional investment banking client activity, such as managing hedging programs. One of its biggest customers was Algeria's state-owned Sonatrach, according to its website.
For Elliott, Hetco is just one of a handful of businesses that are diverting capital and preventing Hess Corp's management from focusing on its Bakken shale oil reserves in North Dakota.
"Shareholders recognize it as a distraction and another example of a business that should not be at Hess," says Quentin Koffey, a portfolio manager at Elliott, founded by hedge fund pioneer Paul Singer. Elliott also trades in commodity markets.
Hendel, a lawyer, and Semlitz, who got an MBA from Cornell, are among a dozen or so commodity executives that are often credited with giving birth to the modern trading industry.
They joined Goldman Sachs at the end of the 1970s, just before Wall Street's biggest bank bought J Aron, the storied commodity trading firm that would become its main vehicle for delving deeper into proprietary trading.
Hendel and Semlitz are credited with helping J Aron expand into the energy sphere, making it one of the leading players.
They both became Goldman partners in the vintage class of 1988, alongside current Chief Executive Lloyd Blankfein, who was then head of currency trading at J Aron, as well as former Merrill Lynch chief John Thain and current Commodity Futures Trading Commission chief Gary Gensler.
While Goldman was famed as a "Wall Street refiner," a bank so large that it traded as much "paper" oil as a real refinery, the Steves saw more of a future in the physical market. They built a condensate splitter - converting an ultra-light form of crude oil into jet fuel and naphtha - in Rotterdam in 1994.
But Goldman was going another direction. An initial public offering was right around the corner, and the focus was shifting toward derivatives trading. Gary Cohn, now the bank's president, was brought back from London to run the commodities business. The splitter was sold off just a few years later.
In some ways the Steves were ahead of their time.
Over the past few years, it has become common to see many of Wall Street's gutsiest traders take off to start hedge funds or join merchants, often prompted by banks' trading restrictions or curtailed bonuses. It was far more unusual 15 years ago, with most trading talent flowing the other direction.
Things started out well. Leon Hess, Hess Corp's founder and chairman until 1995, had long conducted his own trading through Goldman Sachs; he also knew Hendel's father, who had run a fuel supply business in the Northeast.
In the first 10 years after founding Hetco, Hess Corp recorded after-tax trading profits - including its 50 percent share of the trading firm - of $276 million, posting an unbroken streak of profitability, according to the company's SEC filings.
While Hess Corp conducts some trading on its own account, it also states that its "trading activities are conducted principally through" Hetco, according to the 2011 annual report.
In the four years through 2011, Hetco says it has lost a total of $32 million on trading, with only one profitable year. It showed a $5 million loss in the first three quarters of 2012.
Results from the main London-based firm Hess Energy Trading Company Ltd, filed annually with the UK Companies House, show a similar trajectory: modest, growing profits through 2007, then sizeable losses in three out of the last four years, enough to wipe out half the previous decade's profits.
Hetco is by no means alone. Energy markets have proven particularly treacherous for veteran traders in recent years, with prices whipsawed by a European debt crisis and other factors far beyond supply and demand fundamentals.
It is far from clear that Hetco will ever be put up for sale. Chief Executive John Hess's attachment to the unit runs deep, according to industry executives who know the company.
But Hess Corp has begun to shed some of its non-upstream assets, announcing plans last month to shutter its lone refinery in New Jersey and sell its terminals business.
That is unlikely to affect Hetco directly, since it has long traded with Hess Corp at arm's length, industry sources say. Indeed, in the early days of Hetco's operations, Hess Corp's own traders were reluctant to deal with the venture at all, preferring to trade directly with end-users rather than middlemen, sources say.
Hetco has rarely imported fuel to the U.S. East Coast, where most of Hess Corp's facilities are located, according to government data. For the past few years the trader has imported gasoline blending components from the Hovensa refinery in the Virgin Islands, a joint venture between Hess Corp and Venezuela's PDVSA. But the volume of its business was no larger than rivals Vitol and Trafigura, who have no affiliation with the refinery's owners, the data show. The plant shut a year ago.
The question of capital is more disquieting. If a buyer is to be found, it may well come from much further afield. The sovereign wealth funds of Singapore, China and Qatar have all taken stakes in commodity traders in recent years.
"We are seeing folks in developing parts of the world who want to get into trading," says Michael Denton, a partner at consulting firm Oliver Wyman who advises companies on commodity risk management.
"Entities who have not traditionally been in the business are looking at it ... trying to enhance margins and optimize their operations."