Did JPMorgan Chase and Morgan Stanley Make the Right Call in Exiting the Commodities Business?

As scrutiny rises and commodity revenues fall, JP Morgan Chase and Morgan Stanley are hoping to close deals allowing them to withdraw from certain commodities. But there's no guarantee the withdrawals will be smooth and painless for all.

Apr 4, 2014 at 7:00AM

Commodity
Source: Wikimedia Commons.

Raw materials aren't as attractive as they used to be, especially for investment banks. That's why firms, such as JPMorgan Chase (NYSE:JPM) and Morgan Stanley (NYSE:MS), plan to either exit the commodities business or drastically reduce their footprint. Regulators and critics are highly supportive of the exodus in general, but that doesn't guarantee smooth sailing for all.

The 10 largest banks saw revenues from commodities fall 18% in 2013, according to data from analytics firm Coalition. The pool of money has been shrinking for several years, and as it has, public and regulatory scrutiny has expanded. Authorities, including the Federal Reserve, are now tossing around ideas for tighter regulations, and many banks are drawing the conclusion that commodities, or at least certain commodities, just aren't worth the hassle.

Regulators cry foul, JP Morgan pulls out
Playing in the commodities business has certainly earned JPMorgan Chase its share of scrutiny. Last year the bank faced a lawsuit for manipulating the silver market. The case was later dismissed. The Federal Energy Regulatory Commission (FERC) accused the bank of energy manipulation. JPMorgan didn't admit guilt but did agree to pay a $410 million fine. Meanwhile, the bank has been under increasing pressure from the Fed to get rid of Henry Bath, a commodities warehousing unit.

Pipeline

Source: Wikipedia / Steve Hillebrand.

This month, the company announced that it's set to sell its physical commodities business to Mercuria Energy Group. For $3.5 billion, JPMorgan will get rid of $3.3 billion in assets, including Henry Bath, and will exit dealings in products such as energy, petroleum and base metals, though the firm will continue "traditional banking activities" such as storing and trading precious metals.

This deal is expected to close in the third quarter. Bank executives and investors are likely counting down the days until they can say goodbye and good riddance to the commodities unit.

Will Russian sanctions become a hurdle?
Morgan Stanley is also hoping to celebrate a retreat from commodities. In December, the bank announced plans to sell its oil trading division to Rosneft, a Russian petroleum company. That deal was also expected to close this year, but the U.S.' turbulent relations with Russia may complicate matters. Rosneft is a state-run corporation, headed by Igor Sechin, described as "a close ally" of Russian President Vladimir Putin, by the Financial Times.

Sechin acknowledges more sanctions will be bad for individuals and companies. Harsher measures will be damaging for all sides, "sucking in more and more people like a spiral," Bloomberg says he told reporters. However, he also said he doesn't expect sanctions to have any effect on his company's deal with Morgan Stanley.

Not all will celebrate banks' commodity withdrawals
Withdrawing from commodities seems good for the banks and their investors. The banks claim their exodus will not affect their earnings and will eliminate a batch of unwanted headaches. Commodity businesses, such as Rosneft and Mercuria, can celebrate expansion and reduced competition. Commodity investors and industrial users may finally feel the markets are a little more just as well.

What about businesses that serve the banks' commodity divisions, though? For them, these changes can be a real concern. Many may have to hustle up new clients and negotiate new terms that aren't as attractive.

Oil

Source: Wikipedia / Lars Christopher Nottaasen.

TransMontaigne Partners (NYSE:TLP) is a prime example. The firm provides petroleum terminals, storage, and transportation. It's indirectly owned by Morgan Stanley, which is also its biggest client. Given its plans to exit the oil business, Morgan Stanley is now determining what to do with this company.

TransMontaigne isn't expected to be part of the Rosneft deal, leaving the company unsure of who may control its fate if Morgan Stanley sells its controlling stake. Another risk is that business with Morgan Stanley could fade, wiping out the bulk of the company's revenue.

For companies like TransMontaigne, banks making exit from commodities is no minor matter. It's a game changer, and is one that certainly risks having a material financial impact.

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Michelle Smith owns shares of JPMorgan Chase. The Motley Fool owns shares of JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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