Shale revolution lures trading houses to U.S. energy assets
LYNN DOAN and DAN MURTAUGH
GENEVA, Switzerland (Bloomberg) -- Merchants from Vitol Group, to a company backed by billionaire Paul Tudor Jones are amassing physical energy assets in the U.S. at an unprecedented rate as shale output revives stagnant fuels markets.
Castleton Commodities International, financed in part by hedge fund managers Tudor Jones and Glenn Dubin, acquired Texas gas wells in February. Mercuria Energy Group is buying JPMorgan Chase & Co.’s physical commodities business. Vitol and Trafigura are helping build oil pipelines, and Freepoint Commodities is investing in offshore production. Of the $1 bn Trafigura has invested in the U.S., the majority was spent in the past five years, the company said.
“International trading companies have been buying assets all along, just not so much in America,” JP Fjeld-Hansen, MD of Musket, a commodity supplier and trading company in Houston, said April 29. “Now we’ve had this renaissance of U.S. energy markets and they’re bringing their capital here.”
The world’s biggest commodity merchants, most privately owned, are buying or building more physical assets in the U.S. as drilling technologies unleash record oil and gas volumes from shale, creating arbitrage opportunities between regions. They’re also stepping in as banks including Barclays, JPMorgan Chase & Co. and Morgan Stanley reduce their commodity businesses as returns decline and regulatory scrutiny intensifies.
“Companies are realizing if you can understand the physical flows, there’s a value chain from source all the way through to consumption here,” Gary Morsches, MD for global energy at CME Group in Chicago, said in an interview at Bloomberg’s Houston office this month. “You don’t care whether prices go up or down because you know you can arb 50 cents out of this because of your supply arrangements.”
Trading companies are buying or building U.S. infrastructure even as forecasts show production in shale plays from North Dakota’s Bakken to Texas’s Eagle Ford will peak around 2020. Those investing with the expectation that the boom will last for decades are “way out of line,” Arthur Berman, a petroleum geologist and energy consultant in Houston, said April 11 by telephone.
“Everything I see in the Bakken or the Eagle Ford generally says we’ve got years of production, not decades, and that’s an outcome way outside of the public’s perception,” Berman said. “I can’t speak for the people making these investments, but if their assumption is that this thing will just keep on going, I don’t see that.”
Total U.S. oil output will peak at 9.61 MMbpd in 2019, based on an Energy Information Administration reference case. The agency sees tight-oil or shale volumes topping out at 4.8 MMbo in 2021.
West Texas Intermediate crude futures fell 32 cents to settle at $99.42 a barrel on May 1, 2014, on the New York Mercantile Exchange. Prices have risen 1% this year.
Vitol, is working with Sunoco Pipeline, based in Philadelphia, to build a pipeline that will carry oil to the Gulf Coast from Midland, Texas. It also has signed a contract to build LPG terminals in the U.S. Virgin Islands to supply power plants.
The company says it traded 276 Mmt of crude and petroleum products previous year, compared with 261 mn in 2012, and doubled coal trades to 51 mt.
“You’ve got a situation in the U.S. with increasing production, which we expect to continue to increase, so significantly new streams, new places to go with those streams, those streams do need to be moved, and therefore a growing business,” Ian Taylor, Vitol’s CEO, said in an interview at the FT Commodities Global Summit in Lausanne, Switzerland, on April 1.
Trafigura, based in Amsterdam, reached an agreement in November with Energy Transfer Partners in Dallas for capacity on a line that will carry oil and condensate to Corpus Christi from Texas’s Eagle Ford shale formation. It signed a contract with Tulsa, Oklahoma-based Magellan Midstream Partners in March for a condensate splitter in Corpus Christi.
“The relatively low interest-rate environment, in particular for medium and longer-term funding, has helped make investments in fixed assets linked to commodities more attractive,” Bryan Keogh, Trafigura’s North America CFO based in Houston, said in an emailed statement April 29.
Merchants were last this active in physical assets in the early years of the last decade, said Skip York, VP of Wood Mackenzie’s downstream consulting group. The deals then were more sporadic and spread out, he said by telephone March 27.
“It’s hard to quantify what we’re seeing now because it’s unprecedented,” York said. “We’ve never seen the trading houses make these many moves into the physical space in such a short period of time.”
In February, Castleton, a Wilton, Connecticut-based merchant, bought more than 500 natural gas wells and 80,000 acres in mineral leases in East Texas. It’s also developing a condensate splitter complex in Corpus Christi and said today that a subsidiary had bought a gas-processing plant in New Mexico and 362 kms of gathering lines from a unit of Anadarko Petroleum.
Mercuria is buying JPMorgan’s physical commodities business, giving the Larnaca, Cyprus-based company gas and power trading operations on both sides of the Atlantic.
It would also inherit an oil-trading book that includes 6 MMbo of storage leases in the Canadian oil sands and a contract to supply crude to the largest refinery on the U.S. East Coast in return for refined fuel.
Barclays, based in London, said April 22 that it will withdraw from most global commodities activities to focus on electronic trading. Morgan Stanley in New York has agreed to sell a unit that stores and trades oil products to a subsidiary of Russia’s Rosneft.
Banks are scaling back commodities operations amid concern among federal regulators and policy makers that banks could influence prices if they control and trade physical commodities, or suffer catastrophic losses that would endanger the financial system.
Financial holding companies that own physical commodities assets “pose significant safety and soundness, legal, and reputational risks,” U.S. Senators Sherrod Brown, a Democrat from Ohio, and Elizabeth Warren, a Democrat from Massachusetts, said in a statement April 16.
The U.S. Federal Reserve has said it’s considering new limits on trading and warehousing of physical commodities. Legislators are exploring ways to restrict ownership and trading of commodities. New global capital requirements have also made it more expensive for banks to hold commodities.
“They’re going to leave a big hole in the marketplace,” Chip Register, MD of Sapient Global Markets, a consultant in Boston, said March 21 by telephone. “There’s a lot of arbitrage opportunity and money to be made there.”
Amit Bhandari founded Houston energy merchant BioUrja Trading in 2006 and bought a shuttered refinery in Albany, New York, the following year, turning it into a terminal to load ethanol from the Midwest onto barges. The company now runs seven truck-and-rail loading operations for ethanol, crude oil and refined products trading.
“These assets have really appreciated in value,” Bhandari said March 21 from Houston. “People are realizing, ‘Why pay rent? Why not own?’”
In August, Stamford, Connecticut-based Freepoint said a subsidiary, along with affiliates of Apollo Global Management and Summit Partners Credit Advisors, spent more than $110 mn on oil and gas blocks in the Gulf of Mexico.
Traders’ expansion into U.S. physical assets may mark the re-emergence of a “great merchant class” that formed in the 1990s around the time of Enron, said Register of Sapient Global Markets. Houston-based Enron, which had a strategy of buying physical capacity and leveraging it in trades, declared bankruptcy in 2001 amid an accounting scandal.
While Enron’s empire crumbled, its use of physical assets proved to merchants that such a model could work, said Saule Omarova, a law professor at the University of North Carolina in Chapel Hill, whose research primarily focuses on the regulation of financial institutions and banking law.
“In effect, that’s probably the best model for them,” she said March 27. “That’s why the commodities traders are trying to get in.”