By Cezary Podkul and David Sheppard and Scott DiSavino
NEW YORK Dec 21 When federal regulators
proposed a six-month penalty on JPMorgan Chase & Co's
electricity trading arm last month, they took aim at what is now
a rare sight on Wall Street: a large and growing power sales
After five years of rapid and lucrative growth, the world's
biggest investment banks are now dramatically scaling back their
U.S. power operations, a Reuters analysis of electricity sales
In 2008, when they were most active in the market, the 15
biggest banks sold enough electricity in the United States to
power two out of every five residential customers for a year,
Reuters found. By last year, their sales would only power about
one out of every five customers.
The pull-back means fewer deep-pocketed players in an
already shrinking $200 billion U.S. physical power market
and strongly invites the question of who will fill the banks'
role of cushioning the risks of buying and selling in one of the
world's most volatile commodities.
"If big banks leave the market . . . it means that somebody
else has to absorb those risks. And it could be utilities or
consumers - those would be the two leading candidates," said
Craig Pirrong, a University of Houston professor and expert in
energy trade regulation.
Others cheer the exit as a potential win for consumers.
"All the banks are doing is feasting on overly complicated
market rules to find vulnerabilities, which they pounce on to
make large short-term profits," said Tyson Slocum of Public
Citizen, a consumer advocacy group.
Regardless, some electricity buyers are already expressing
nervousness about JPMorgan's penalty. The bank had been
one of just four banks, alongside Bank of America Merrill Lynch
, Australia's Macquarie Group and Germany's
Deutsche Bank, to sell more electricity in 2011 than
in 2008, according to quarterly data sellers are required to
provide to the Federal Energy Regulatory Commission (FERC), the
country's top power market regulator.
Others have pulled back sharply. Total power market sales
reported by Goldman Sachs in 2011 fell to one-sixth of
their peak in 2005. Total sales by the banks have continued to
slide in the first nine months of 2012 and are almost half the
level of a year ago.
There are many reasons for the decline. Power prices have
fallen to 10-year lows across most of the United States thanks
to an abundance of cheap natural gas. With decades worth of
cheap fuel ahead, fewer utilities have been looking to hedge
their output; tough new capital requirements and regulations
banning proprietary deals have cut into commodity trading; and
some European banks, facing a persistent debt crisis back home,
have fled dollar-intensive businesses.
But many bankers and analysts see a more alarming cause for
the pull-back by banks: the risk that a more aggressive FERC may
target them for anything suggestive of nefarious trading.
BANKS' SLICE SHRINKS FASTER THAN PIE
While the total value of the U.S. physical power market has
shrunk in recent years, the banks' share has fallen faster.
At their height in 2008, banks sold $46.2 billion worth of
electricity across all products, or about 15 percent of the U.S.
physical power market. In 2011, they sold $17.5 billion, or
about 9 percent. In the first quarter of this year, their share
was down to just under 7 percent, FERC data show.
Reuters gauged each bank's footprint in the power sector by
analyzing quarterly logs of physical power transactions they
have filed with FERC since 2002. Reuters shared the data with
each bank represented in the filings, and while all declined to
comment publicly for this article, none disputed the figures.
"The pie is definitely shrinking and has been for a few
years," said the global head of one bank's power operations.
"Our hope is that we are nearing the bottom."
Some of that gap has been filled by hedge funds or merchant
traders not facing the same limitations as banks; but, say
traders, some of that liquidity has simply evaporated.
FERC's stepped-up enforcement has grown increasingly
apparent since 2005, when Congress beefed-up its penalty powers
to help prevent another Enron scandal.
In November, the agency imposed the temporary ban on
JPMorgan's physical power trading - over no more than a document
discovery dispute in an investigation that is not yet finished.
The ban will limit JPMorgan's ability to sell power at
profitable rates for six months starting in April 2013.
Asked about the ban by Reuters, JPMorgan Chase CEO Jamie
Dimon brushed it off this month as "not that big a deal" for the
bank, which is contesting the punishment.
Not everyone is so blasé.
Several customers of the bank -- which includes a range of
local utilities from Palo Alto to Seattle -- expressed worries
about the impact on their routine power purchases.
"I don't think we are going to get any bid [from JP Morgan]
because it takes away their vested interest in getting into
these trades," said Yakov Levin, manager of the power department
for the Town of Hudson, Massachusetts, which has bought power
from the bank.
The California city of Palo Alto "took steps immediately to
ensure we wouldn't set up any more deals with during
the ban," said Debra Katz, who handles communications for the
city's utility. It wasn't ideal since "we've been very happy
with our transactions with JPMorgan in the past."
JPMorgan spokeswoman Jennifer Zuccarelli said the bank has
been in contact with its clients regarding the ban and sought
clarification from FERC to make sure it will not impact
The bank's trading counterparties are also taking notice.
One trader who has bought power from JPMorgan said any future
deals with the bank must be "reviewed by our legal and
FERC spokeswoman Mary O'Driscoll said the Commission is not
worried about banks scaling back their electricity trading
"Power markets ebb and flow and change all the time. Banks
have their own reasons for leaving the market," she said.
BOOM AND BUST
Most banks entered the power sector after the California
power crisis in 2000-2001, when several energy marketers like
Enron were driven from the market by manipulation scandals,
bankruptcy and other credit concerns. That left a financing gap
in an industry that had recently become deregulated.
Wall Street sensed opportunity.
Between 2001 and 2005, FERC granted power marketing
authority to at least eight banks. Others bought their way in:
UK-based RBS launched a joint venture with trading powerhouse
Sempra Energy in 2008.
"Everyone was seeing how much Goldman and Morgan
were making," said one executive at a large bank that wound down
its electricity operations after 2008. So banks started "chasing
revenue" by poaching top traders from Wall Street's dominant duo
and hiring promising up-and-comers from utilities, he said.
Banks make money in the sector by buying electricity from
power generators or plants they own or operate. These often
long-term agreements help make costs more predictable and
projects more bankable for power providers. The deals also make
sense to banks, who can then turn around and sell the power to
utilities, cities and industrial users at a slight mark-up.
In all, the value of banks' physical power sales surged
three-fold from 2003 to 2008, FERC data show. But the 2008
financial crisis - and its regulatory aftermath - accelerated
Wall Street's retreat from the market.
RBS was forced to sell its Sempra Energy venture in 2010
after it was bailed out by the UK government. Bear Stearns and
Merrill Lynch, both with large power books, were sold to rivals.
Lehman Brothers went bankrupt.
Others simply found the costs exceeded the benefits of
staying in the market. Credit Suisse lost over $100 million on
Texas power trades that went sour at the peak of the financial
crisis, according to a person familiar with the bank's
operations at the time.
By 2009, Credit Suisse had decided to pull out of power
trading because it was too capital intensive and as they faced
restrictions on trading for the bank's own book, according to a
person familiar with the firm's thinking.
'JIHAD' OR JUST BUSINESS?
Now, some in the industry worry the retreat is accelerating.
Amid a glut of natural gas supply, the market's economics
haven't improved much. But the potential costs have.
When FERC proposed fining Barclays for alleged
market manipulation in October, the record $470 million penalty
more than eclipsed all the bank's physical power sales revenue
for the first nine months of 2012, FERC data show. Even
Barclays' penalties for manipulating Libor - the global interest
rate benchmark - were smaller.
"It used to be that they didn't have significant penalty
authority. So if you messed up, whatever ill-gotten gains you
got, you gave back," said Barbara Bourque, the former head of
FERC's quarterly electric sales reporting, who helped Reuters
analyze the agency's data.
"Now, they can put people out of business," said Bourque,
who runs Energy Compliance Consulting in Phoenix, Arizona.
Besides Barclays and JPMorgan, FERC has also accused
Deutsche Bank of market manipulation, though the agency is only
seeking to impose a $1.5 million fine on the bank.
Deutsche Bank this month made deep cuts in its U.S. power
trading division; Barclays stopped trading West Coast Markets a
year ago. Both banks are contesting FERC's charges.
David Perlman, former chief counsel to Lehman's commodity
trading business who is now a partner at the law firm of
Bracewell & Giuliani, thinks the proceedings could further
dampen banks' enthusiasm toward the power business.
"People are looking at the Deutsche Bank case and they are
looking at the JPMorgan case and they are wondering what the
rules are," Perlman said.
Former FERC Commissioner Marc Spitzer, now a partner at the
law firm of Steptoe & Johnson, says the agency is simply doing
"The argument that FERC is on a Jihad or a crusade against
banks is not accurate," he said. Spitzer said FERC is just
following up on tips it receives from the marketplace, which
could come from regional regulators or even rival traders.
For now, at least, more cases like Barclays could be on the
way. FERC has increasingly gone after market manipulators under
the tenure of current enforcement chief Norman Bay.
During the last three years, 56 percent of 43 investigations
opened by FERC involved market manipulation, according to a
Reuters review of the agency's enforcement data. That compares
with 42 percent of the 93 investigations opened by FERC in the
three years prior to Bay's tenure.
Asked earlier this month by Reuters whether the agency is
trying to push banks out of the power markets, FERC Chairman Jon
Wellinghoff brushed off the suggestion.
"We're an equal opportunity enforcer."