The Undead Enron Model Returns to the World above Ground

zombiechinaOur readers are probably aware by now that Mercuria has closed on its purchase of JP Morgan’s energy trading business. The deal was done on the third of October.

Mercuria Energy Group, a Swiss company, got its start in 2004, a moment when the energy trading business was still trying to re-organize itself after the rapid disorienting fall of Enron. And therein hangs a tale. This transaction is at least in part a case of Enron’s Revenge. A Halloween tale where a business model thought dead returns….okay, let’s not get too dramatic.

As the CEO of Mercuria, Marco Dunand, said in a recent statement, the goal of the private company’s founders was precisely “to develop a global energy-focused commodities group,” and with this step they may be said to have accomplished that.

They received an assist from a variety of considerations that made J.P. Morgan more willing to sell this property than it would have been in 2004 or in much of the intervening decade. Likely the most important of these considerations is the Volcker Rule, which after all, was designed to restrict the proprietary operation of banks. The rule first became law as a matter of statute in 2010, but it has taken a long time for the implementation to work its way through regulatory draftings, notices, comments, and re-draftings, to the point where the banks are just now engaging in such divestiture.

J.P. Morgan isn’t alone in this. In December 2013, Morgan Stanley sold its physical oil business to a company that is majority-owned by the Russian government: Rosneft. [Subsequently, I’m happy to report, that government has taken some steps toward the privatization of Rosneft.]

The Federal Reserve Too

Further, it isn’t only the Volcker rule that is driving banks out of the field. The Federal Reserve has under consideration a change in its rules that would place “additional restrictions [on] physical commodities activities authorized for financial holding companies.” Holding companies have been allowed to “take and make delivery of title to commodities underlying commodity derivative contracts on an instantaneous, pass-through basis” and to enter into derivatives contracts that don’t require cash settlement, only since August 2003. And that permission may not last forever.

Meanwhile, in another getting-out-of-commodities deal (though not one that involves energy commodities specifically) Goldman Sachs is said to be looking for a buyer for its metals-warehousing business. This would rid it of various regulatory and public-relations nightmares.

If we look at the Big Picture over the last few years we see this: Enron’s collapse made a lot of energy merchants nervous about engaging in the proprietary trading in energy commodities and their derivatives. The banks moved into the space – with the blessing of regulators and central bankers! – precisely because nature abhors a vacuum.

EnronOnline itself went from the custody of the bankruptcy court to that of UBS. Though UBS closed the operation within a year, that transfer suggests the broader merchants-to-bankers turnover.

So now: what?

It appears that we’re coming full circle. Regulators and central bankers are now chasing the bank holding companies out of the market, and since somebody is going to do the crucial work of market mediation/greasing/hedging, those merchants who have stuck it out, like Mercuria, are the natural beneficiaries.

Two oil companies sought to expand their line and fill this potential vacuum themselves last year. Both BP and Shell registered as swap dealers.

A recent discussion in TABBForum by two executives of Sapient Global Markets and a London-based political consultant raises the issue of how this change-over affects the end users of those commodities. Ujjwal Deb (VP at Sapient), Rashed Haq (VP of Business Consulting), and Lukasz Hassa (the consultant) say that end users should be concerned that the new merchant traders don’t have or even perhaps understand the “sophisticated hedging and other financial products” with which banks have provided them. Yes, merchants can be expected to “ramp up in this area” if it proves lucrative, but they’ll “face a steep learning curve in terms of process and system sophistication” as they do so.

Further, the Mercuria’s of the world have much smaller balance sheets than the JPMs. This, according to Deb et al., suggests a limit to the liquidity they can bring to the table with them.

That point is not entirely convincing. Liquidity turns on the content of the balance sheet, not its size alone – or even its size mostly. Further, I for one am not entirely convinced that liquidity is an unmixed blessing. Too much of it indicates physiophobia, which may have been behind the troubles of Enron all those years ago.

Still, the turn of the wheel of fate makes a great spectacle.

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