JPMorgan Commodities Exit May Sap Liquidity Until Others Step in

A decision by JPMorgan Chase & Co. (JPM) to exit its physical commodities business would temporarily reduce market liquidity before other companies quickly take its place, according to analysts and traders.

New York-based JPMorgan, the largest U.S. bank, said yesterday that it’s “pursuing strategic alternatives,” including the sale or spinoff of its commodities business, after an internal review. The statement came three days after a congressional hearing investigated whether deposit-taking banks should be allowed to trade raw materials such as oil and industrial metals.

JPMorgan owns and trades financial and physical commodities including crude oil, natural gas and power, and describes itself as “one of the world’s leading energy market makers.” The bank may be the first to exit physical commodities, though others may follow if regulations are changed, as suggested by Senator Sherrod Brown, an Ohio Democrat whose subcommittee of the Senate Banking Committee held the July 23 hearing.

“It looks like they want to get ahead of what appears to be a new wave of regulation that will limit the activities of the banks in the commodities sphere,” said John Kilduff, a partner at Again Capital LLC, a New York hedge fund that focuses on energy.

Regulators need to take a “long, hard look at the practice of banks holding physical commodities,” Brown said in a statement before the hearing. JPMorgan’s decision to consider selling or spinning off its commodities business is “good news for consumers and taxpayers,” he said in an e-mail yesterday.

Liquidity Drop

While the exit of JPMorgan and other banks may reduce liquidity in the short term, they will be replaced by commodities-trading firms such as Switzerland-based Glencore Xstrata Plc. (GLEN), Kilduff said.

“Maybe JPMorgan is just getting ahead of the game a little bit,” said Tariq Zahir, a New York-based commodity fund manager at Tyche Capital Advisors. “Commodities have been part of their business, but not a big driver of their revenue. If Goldman or Morgan Stanley (MS) decides to get out of commodities, people will definitely take more notice of that.”

The effect on the market of JPMorgan’s exit may depend on whether the commodities business finds a new life, either on its own or in the arms of a buyer.

“If JPMorgan were to sell or spin off the physical commodities business and it became a new entity, the impact on the market would be minimal,” said Andy Lipow, president of Lipow Oil Associates LLC in Houston. “If JPMorgan were to just shut it or sell to someone with the same business, that may sap liquidity from the market.”

Metal Warehouses

The congressional inquiry came three weeks after the London Metal Exchange said it wants to help unclog growing queues at repositories, which companies ranging from beer makers to wire fabricators say have reduced the availability of aluminum and copper.

At the same time, prospects for gains in commodity prices may be dimming. Analysts at banks from Citigroup Inc. to Goldman Sachs Inc. have said the decade-long commodity bull market is ending after higher prices spurred expansions at mines, farms and oil fields.

Increased regulatory scrutiny of banks and commodities, along with the outlook for lackluster gains in many raw materials, provides a “one-two punch,” to bank commodity businesses, John Stephenson, who helps oversee about C$2.7 billion ($2.6 billion) at First Asset Investment Management Inc. in Toronto, said in a telephone interview.

“The banks are saying ‘I don’t need the hassle, and there’s no money to be made anyhow,” Stephenson said. “If it was the only game in town, and you were printing money, and there were just a few pesky regulators hanging around, that would be another thing. But with the light being shone now, the implications are very negative.”

To contact the reporters on this story: Edward Welsch in Calgary at ewelsch1@bloomberg.net; Joe Richter in New York at jrichter1@bloomberg.net.

To contact the editors responsible for this story: Dan Stets at dstets@bloomberg.net; Steve Stroth at sstroth@bloomberg.net.

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