Financial Times: Oil in the workings of high finance: “BP, Total and Shell now have trading teams that rival the biggest banks in terms of trader numbers, an ingrained entrepreneurial culture - which causes worries about risk at the credit rating agencies - and highly advanced IT systems. Shell employs 240 oil traders, while BP and Total's teams are bigger still”: "A very big global oil company is in the physical market all the time and there is an enormous information flow coming out of the business on a physical level on a daily basis. This gives the oil trading divisions an in-built advantage over the market, and they use it." (ShellNews.net) 20 Dec 04

By James Boxell

Published: December 20 2004

While the world's biggest oil groups have been making bumper profits recently on the back of record crude prices, there is one part of the business that is also doing very nicely - but they keep quite quiet about it. 

BP, Total of France and, to a slightly lesser extent, Royal Dutch/Shell have substantial oil and gas trading units that rival - and in some cases surpass - the large banks, the more traditional home of the commodity trader.

These companies, which clearly dominate the "physical" trading of oil, are also becoming more active in the futures and derivatives markets - an area where banks and other financial operators have traditionally led.

But if investors are looking for details on how much these units make for the oil companies or on the nature of their trades, they will come up empty-handed.

A former trader says: "These guys must be making a huge amount of money because of the huge amount of volatility in the market in the past year or two, in the same way as the banks who are hiring commodity traders like they are going out of fashion."

However, profits from the trading divisions are hidden in the overall figures for exploration and production or refining and marketing, and this lack of transparency about a risky area of business causes nervousness among credit agencies and investment analysts.

An analyst at a leading credit rating agency says: "The public disclosures for the trading arms are not up to the levels required. If I was a backer, I would go on what is disclosed in annual reports and I would have a very vague idea of trading operations. They are getting banking lines to support these arms as if BP Trading, for instance, should have an equivalent rating to the whole of BP, but the operation presents much more risk. Trading arms have grown to support upstream operations but they don't separate what is hedging and what is physical trading. We are unsure what is pure trading."

Companies, such as BP, Shell and Total, have a long tradition of trading their physical commodities as a way of making sure they operate their supply chains efficiently. If BP has an oilfield close to an ExxonMobil refinery, it makes more sense for BP to sell that oil to Exxon than to ship it the greater distance to its own refineries. If Exxon had petrol stations close to a BP refinery, it would make more sense to buy BP's petrol.

However, some companies have realised that there is good money to be made in providing the kind of complex, non-physical trading instruments that were the mainstay of the banks.

One head of a leading bank's commodities trading desk says: "They thought, why should we just hand this work to the banks. BP, for example, is extremely sophisticated in the kind of products that it offers to its industrial client base to take away future energy price risk."

The outcome is that BP, Total and Shell now have trading teams that rival the biggest banks in terms of trader numbers, an ingrained entrepreneurial culture - which causes worries about risk at the credit rating agencies - and highly advanced IT systems. Shell employs 240 oil traders, while BP and Total's teams are bigger still.

ExxonMobil, the world's biggest oil group, refuses to get involved in non-physical trading. "It's a cultural thing," says the former trader. "They just don't believe in paper markets."

The oil companies that do partake have a competitive edge on their banking peers, according to rival traders. One says: "A very big global oil company is in the physical market all the time and there is an enormous information flow coming out of the business on a physical level on a daily basis. This gives the oil trading divisions an in-built advantage over the market, and they use it."

However, the trading desk head says there has been evidence recently of a more cautious approach to speculative trades by the big oil groups because of fears that they could be perceived as manipulating the market.

The Financial Services Authority, the UK's financial watchdog, recently threatened to scrap its light touch regulatory regime for oil market participants because of poor compliance with its rules - although it did not single out any oil companies.

"If a company knows a certain area of supply is tight, it makes sense for them to be buying," the trading desk head says. "But if the price is doubled then the question arises is someone gaming the market, which generates some - mostly uninformed - stories. These companies don't want to expose themselves to increased regulatory or press scrutiny on worries that someone is cornering the market. If you are sitting atop a $100bn business, if someone says we can make $100m over here [from trading], it is not a difficult decision to turn it down if the greater good is at threat."

BANKS IGNORE PHYSICAL TRADING TO FLEX MUSCLES IN $200BN ENERGY DERIVATIVES MARKET Investment banks have left the physical oil trading market to the world's largest oil companies, but the banks dominate the $200bn (£103bn) energy derivatives market with several more banks bulking up their energy trading desks to boost earnings,writes Kevin Morrison. Goldman Sachs and Morgan Stanley have been long-term operators in the energy trading market, a business that has provided large profits in the past two years. But the banks' presence in the physical market has fallen. Goldman once owned its own refinery and chartered up to 4,000 oil tankers a year, but has sold the refinery and now only charters a handful of tankers each year, as it focuses on the derivatives market. Jeffrey Currie, head of commodities research at Goldman Sachs, says about $200bn is in energy derivatives, mostly in the self-regulated over-the-counter market.