July 29, 2013 / 4:01 AM / 6 years ago

For the Masters of commodities at JPMorgan, a sense of deja vu

NEW YORK, July 29 (Reuters) - Fifteen years ago, a boom in global commodity trading was underway, and JPMorgan was late to the game.

Trying to catch up with Wall Street rivals, JPMorgan recruited a young trader, Danny Masters. Within a few years, it had built a global platform that eclipsed its peers. At last it was a major player in markets from oil to metals.

Then it pulled the plug. Regulatory scrutiny in metals markets had tarnished its reputation; the gains from shipping oil around the world no longer seemed worth the risk.

On Friday, history repeated itself.

JPMorgan Chase & Co. announced it would try to sell or spin off its physical commodity trading assets and operations, dismantling an empire built over five years by commodities chief Blythe Masters, 44, ex-wife of Danny Masters.

The announcement came almost 15 years to the day after the bank said it would end its first big foray into raw materials, led then by Danny when the couple was still married.

The operations for sale now account for as much as two-thirds of the bank’s $2 billion-plus commodity revenues. They include 72 metal warehouses, three power plants, oil contracts and hundreds of traders from Singapore to Houston.

What remains will be a more traditional derivatives and precious metals operation, not unlike what the bank had in the early 1990s, when J.P. Morgan & Co. hired Danny Masters to help break into the ranks of the “Wall Street refiners,” banks like Morgan Stanley and Solomon Brothers that were driving growth of the modern oil market. His team became major players in the dynamic European crude market.

“For a year or two, there was nobody bigger than JP Morgan,” said one senior industry executive in London.

Around the same time, JPMorgan was building up a large London base metals business, a new area for banks.

None of it would last.

In 1996, J.P. Morgan was named as one of at least four banks caught up in the Sumitomo Corp. copper trading scandal, when rogue trader Yasuo Hamanaka racked up $2.6 billion in unauthorized losses. Morgan, which had loaned money to the Japanese trading firm, was the only bank to be rapped by regulators for lax controls. It wound down the London desk by 1997 to focus on customer business, it said at the time.

In July 1998, a year after Masters was named to lead the global energy business, the bank announced plans to sell the 35-person trading team, a fraction the size of its current 500-plus commodities division. An executive said at the time that a buyer with a strategic focus on energy trading “was in the best interests of clients, employees and Morgan overall.”

Six months later, it shut down the unit after oil slumped to $10 a barrel, discouraging potential buyers. In 1999, Danny Masters set up one of the first commodity-focused hedge funds. He could not be reached to comment for this story.

Cambridge-educated Brit Blythe Levett, who had interned at JPMorgan since 1987, had barely begun her career on the commodities desk when the bank launched its bold plan.

She married Danny before he joined JPMorgan, and left the commodities group before he started. She later won acclaim for helping create credit derivatives. In 2001, they divorced. Five years later, Blythe Masters returned to commodities.

She did not respond to email seeking a comment for this article, and the bank declined to make her available.


By 2004, oil prices were pushing past a record $50 a barrel, copper was $3,000 per tonne, and investment banks were again piling into commodities. Merrill Lynch, Barclays and Deutche Bank were gaining on Goldman and Morgan Stanley, which had enjoyed years of dominance.

JPMorgan saw “huge potential” in the business and believed it could compete with the two big rivals, says a person familiar with its commodities business at the time.

The bank hired Morgan Stanley’s top power and gas trader, George “Beau” Taylor, to jump-start the effort. He beefed up the desk with big trades and doubled the energy team to 70 within a year. He said at the time he wanted to add more of “the proper rainmakers in the right seats.”

The next year, the bank scored a coup when one client, hedge fund Amaranth Advisors, melted down after bad natural gas trades. JPMorgan and hedge fund Citadel took over Amaranth’s trades and earned an estimated $725 million on that deal.

But the business Taylor built lacked a large base of customer flow and produced volatile results, including a sizeable loss in the first quarter of 2006, although annual results were strong, according to former employees.

In March 2007, JPMorgan Chairman and CEO Jamie Dimon told analysts the bank had “not had the level of earnings stability that we would have liked in energy.” Value at risk in commodities, a measure of the bank’s own money being wagered, more than doubled to an average $45 million a day in 2006; Goldman Sachs’ VaR, by contrast, was $30 million.

As the bank refocused more on client-driven business, rather than proprietary trading, Taylor left for a rival months later.

This was a period of turmoil in the trading business. Dimon restructured the foreign exchange and commodities groups three times in seven months. Blythe Masters, who had been the investment bank’s chief financial officer since 2004, took over on a temporary basis in late 2006 and then, in mid-2007, was formally named to run the commodities group.


The following year would mark the start of an acquisition spree that would transform the bank. But it would still take years for Masters to get the business firing on all cylinders.

One of her first public appearance after taking over the group was before a Senate subcommittee to talk about JPMorgan’s global environmental products trading division, and push for a U.S. scheme. The bank’s role in the still-young carbon market was going to be “her thing,” said one former employee.

“For the private markets to most effectively address the problem of climate change, greenhouse gas emissions, which practitioners refer to as carbon, must have a price,” Masters told lawmakers at the July 2007 hearing.

In early 2008, JPMorgan bought carbon offsetting company ClimateCare. In September, 2009, it paid $200 million to acquire UK-based EcoSecurities, which developed clean energy programs and carbon offsets as part of the Kyoto protocol.

But efforts to create a U.S. emissions trading scheme were collapsing by 2010, while the European Union’s cap-and-trade system, the world’s biggest, went into freefall amid a glut of credits and a dearth of confidence in new global curbs. ClimateCare’s management took the firm private in 2011.

In the meantime, JPMorgan was doubling down on traditional markets. In the early days of the 2008 financial crisis, it took its first step back into physical trade, buying Bear Stearns, along with its power plants and large trading book.

The following year it bought UBS’s global agricultural book and Canadian energy unit, a group that once worked for Enron.

The biggest deal came in early 2010. Royal Bank of Scotland, bailed out by the UK government, was forced to sell off the Sempra Commodities group it had bought a majority stake in just before the crisis struck.

In July 2010, Blythe Masters closed the $1.7 billion deal, acquiring a global physical oil trading platform with a history of big risks, and big rewards. It also had a premier base metal trading and warehousing division that traced its roots back to Metallgesellschaft (MG), the German enterprise that dominated the London market in the 1990s.


That same year, JPMorgan suffered what Masters called a “rookie” loss in illiquid coal markets estimated to have cost the bank as much as $250 million. She was also enraged by the publication of an internal conference call on which she told the group’s 600 traders that competitors were “scared shitless”.

Some of the traders at Sempra had already been chafing at the more restrictive environment of a bank. In 2011, some of them followed their former bosses to a new trading house called Freepoint Commodities, backed by a private equity fund.

After these setbacks, the group seemed on track by mid-2012.

In April last year, Blythe Masters inaugurated the first educational program in the United States dedicated to broad commodity trading, at the University of Colorado. Its lab was filled with rows of trading terminals and premium data services.

She told CNBC at the time that JPMorgan expected client demand for commodity finance, risk management and trading to grow “very, very rapidly over the next couple of decades in fact. ... we are very excited about the prospects for growth.”

Last July, JPMorgan clinched a deal that would make it the 11th largest U.S. oil importer: a three-year contract to supply crude and sell products from the 330,000 barrel per day in Philadelphia, the biggest on the U.S. East Coast. It was part of a wide-ranging financing deal that helped Carlyle Group buy the plant, saving it from closure.

The deal showed how the combination of “physical capabilities with our financial risk management and structuring skills” offered “unique differentiators,” Roy Salame, head of global sales and structuring, told Energy Risk magazine in May.


By the time JPMorgan was named Risk’s “Oil and Products House of the Year” two months ago, however, things had already begun to sour behind the scenes.

The Federal Reserve, which for the past decade has allowed commercial banks to trade broadly in physical markets, from Middle East crude to power plant tolls, was looking more closely than ever at how banks were operating in these markets.

A “review” of its landmark 2003 decision, made public in an abrupt announcement last Friday, had in practice been underway for months as the regulator queried other banks on pending requests, according to a source who speaks to the Fed regularly.

The Federal Reserve has declined to comment on the review, or any discussion with any specific bank on commodities.

A Reuters report in early 2012 made it clear JPMorgan would probably have to sell off the Henry Bath operation. Even deeper questions arose that had forced the bank to review the future of the business.

In February, Michael Cavanagh, a co-chief executive of the corporate and investment bank, told investors that because of “changes in regulation, particularly around the physical side” it would be looking to “optimize” the commodities group.

The next month, the U.S. power market regulator told JPMorgan it was looking into allegations that JPMorgan manipulated power markets in the Midwest and California.

Pressure on the bank mounted last week, when a U.S. Senate banking subcommitted grilled experts over whether investment banks should be allowed to own warehouses and trade oil tankers, putting unprecedented scrutiny the sector.

On Friday, after announcing the bank’s exit, a spokesman said simply: “We considered many different factors, including the impact of potential new rules and regulation.”

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