Top of the league

In a year of volatile oil prices, geopolitical uncertainty and a new push to develop alternative energy sources, Morgan Stanley and Goldman Sachs have cemented their position as the top energy derivatives shops. By Oliver Holtaway, with research by Xiao Long Chen

Even with oil prices slipping, investors continue to enter the commodities markets in droves, while corporate end-users are becoming increasingly sophisticated in the hedging of their energy exposures. This, in turn, has increased competition within energy derivatives trading, particularly in the more liquid, vanilla products.

This year's Energy and Commodity rankings reflect the fierce competition among dealers active in the energy markets. However, while a number of firms expanded their businesses over the past 12 months, Morgan Stanley and Goldman Sachs remain clear market leaders, dominating the oil, natural gas and electricity categories of this year's poll.

Morgan Stanley edged out Goldman Sachs to top the overall oil and electricity categories, with 14.2% and 10.2% of the vote, respectively (see page 58 for leaderboard). It also improved one place in the natural gas segment, taking third place with 9.6% of the vote. Overall, the dealer came first in 20 of the 54 oil, natural gas and electricity sectors this year, versus 13 top spots in 2006.

John Shapiro, global head of commodities at Morgan Stanley in New York, credits the bank's success to competitive pricing and good service, as well as a long-running commitment to the market. "We have people who have been here for many, many years," he says. "We have been committed to this space for a long time, always with consistent growth."

Goldman Sachs lost its position as top dealer in oil and electricity, falling to second and third place respectively. However, it climbed two spaces in natural gas, from third place in 2006 to first this year, with 11.8% of the vote. The firm was also overall top dealer across all categories, including metals and grains, with 10.7% of the vote - just ahead of Morgan Stanley in second place with 10.1%.

Peter O'Hagan, chief operating officer for global commodities at Goldman Sachs in New York, also highlights a long-term commitment to the commodities market as key to the firm's continued strong performance in the rankings. Combined with stringent risk management, Goldman Sachs has been able to show earnings consistency quarter-by-quarter, and year-on-year. "Many new entrants see their performance vary unpredictably from profit to loss, which creates business uncertainty," he says. "It's difficult to move with confidence into new markets if your existing business is not stable."

As ever, the dominant position of the 'Big Two' serves as a reminder of how important a physical presence in the market can be. "We have a good balance of participation in the physical and paper businesses, which puts us in a position to have very constructive dialogues with companies' chief risk officers," says Shapiro.

O'Hagan agrees, adding that an asset-focused approach is vital to understanding the business. "Energy is an infrastructure industry, and the better we understand the assets, the better we can provide risk capital to the energy world."

Both banks agree on the value of providing a broad and diverse offering. This means not only expanding into new regions and markets, but also drilling deeper into established markets in order to increase core earnings capabilities. This is becoming even more vital as customers' needs become increasingly sophisticated.

"The range of products that end-users want to use has increased as they have become more experienced. So having that breadth and depth of service is important," says Shapiro. Commodity investors are now looking beyond simple macro oil and gas exposure, and are seeking out relative value opportunities, he adds.

It is unlikely that any bank will be able to unseat either of the Big Two any time soon. Last year, Barclays Capital outperformed; this year, it is the turn of Deutsche Bank to make a strong bid for the title of 'most improved player'. The German bank made a splash in oil, finishing fourth overall and taking the third spot in the flagship categories of West Texas Intermediate (WTI) and WTI options.

Richard Jefferson, Deutsche Bank's London-based head of commodities sales for Asia and Europe, says co-operation with other parts of the bank is key to its business. "We leverage the entire firm's platform to ensure we are delivering the complete customised solution to our clients," he says, adding that the bank will continue to expand its physical capabilities in specific markets in 2007. "We have already made significant strides with infrastructure and the hiring of key personnel with specific physical market knowledge."

BP, one of the few non-bank institutions to figure in the rankings, repeated last year's strong showing, finishing fourth in the overall rankings (including metals and grains), with 7.2% of the vote. In the energy categories, the UK company ranked second overall in natural gas, and fifth in oil and electricity.

BP has built its financial offering on existing physical relationships, a fact that Steve Provenzano, vice-president of financial products origination at BP North America in Houston cites as a strength. "Coming from a physical background, we have a deeper understanding of the risks associated with individual customers' businesses," he says. The energy derivatives team's make-up reflects this, and includes individuals hired from banks, energy merchants and other parts of BP. The company also has the balance sheet to compete with the top banks, he adds.

Meanwhile, Barclays Capital retains its position as the third-ranked dealer across all categories, taking 8.8% of the vote - primarily due to its strength in the metals categories (see pages 54-56). The UK bank came sixth overall in oil, fifth in natural gas and eighth in electricity.

Benoit de Vitry, head of commodities, emerging market rates and quantitative analytics at Barclays Capital in London, believes recent investment in the US energy markets will bear fruit in 2007. "We hired seven traders in US western power and natural gas last year, and we expect to see that reflected in next year's rankings," he says. "We do not just want to be a UK specialist. We are expending the same effort on our US and European operations as we are on our UK operations."

The UK bank also performed well in the coal derivatives and emissions markets, topping the European coal derivatives, European Union emissions trading scheme and certified emissions reductions categories. "We embraced the emissions market from the beginning, not seeing it as just a toy to play with, but as a key part of our commodities strategy," says de Vitry.

Societe Generale Corporate and Investment Banking (SG CIB) was another strong performer, ranking third in the top overall oil dealer category, and finishing fifth overall (including metals and grains) with 6.7% of the vote. Like many of the top banks, SG CIB has also expanded into new markets over the course of 2006.

"We have made a very strong push in the US, where we have gained significant market share," says Franaois-Xavier Saint-Macary, New York-based global head of commodities markets at SG CIB. "Our success is due to our creativity in pushing new markets and the persistent effort we have made to provide liquidity in a consistent manner, even in some adverse market conditions." Saint-Macary says the bank will invest more heavily in US physical gas this year, as well as carbon trading and liquefied natural gas.

Brokers

The big story in energy brokerage last year was New York-based GFI Group's acquisition of Amerex's North American operations. The merger had a positive effect on GFI's performance in the rankings: the broker finished second in natural gas and electricity, and placed second in the overall commodities broker category (which includes metals and grains).

Ian Clague, GFI's managing director for North America, says the close fit of the GFI and Amerex businesses was important. "Historically, GFI focused more on financials, while Amerex had stronger links with physical players," he explains. There was also a geographical difference: Amerex was based in Houston, with a bias towards the western and southern US, while GFI was focused more on the northeast US. "GFI Group as a whole is now a much larger broker across the whole energy complex," adds Clague.

The merger is a reminder of how scale is becoming an increasingly important factor in the energy brokerage game. "Scale matters," says David Pinchin, Stamford, Connecticut-based chief executive of second-ranked overall energy broker Tradition Financial Services (TFS). "The energy business can sustain some smaller players, but scale will matter more in the future."

This seems to have once again been borne out by this year's rankings. The success of independent specialist oil broker PVM, which was the third-ranked overall oil broker, may be the exception that proves the rule, but it was financial services behemoth Icap that ruled the roost in this year's rankings. The broker comfortably retained its top overall broker rankings, garnering 45 top-two rankings from 66 individual energy categories.

But while Paul Newman, Icap Energy's London-based managing director, acknowledges that scale is important, he also points to the firm's philosophy of staff continuity. "In this business, I've never been convinced by the model of the individual rainmaker. Team effort is the best for the brokerage, the brokers and for the customers in the long term," he says. As such, Newman would prefer to invest heavily in training graduates in the Icap culture, rather than paying exorbitant transfer fees for superstar brokers.

Newman also denies that the growth of electronic trading, stimulated in part by increased hedge fund activity, could present a threat to brokers. "We have never believed that electronic trading is an unqualified threat to voice broking," he says. "In many energy sectors, the right model will continue to be thinking of the screen as a tool of the trade, used as an instrument to support strong voice broking offerings."

Brokers are being forced to react to the increased penetration of electronic trading, however. GFI's Clague acknowledges that the success of Ice Futures, the London-registered electronic futures and options exchange owned by Atlanta-based IntercontinentalExchange, in penetrating the short-dated markets for North American gas and power has been a big development.

"We are reacting to this by trying to offer our clients many of the conveniences of exchange trading - for example, greater automation," says Clague. "Investment in technology is now very important."

Elsewhere, London-based brokerage firm Spectron performed well, particularly in UK gas and European power, and the broker is now looking at expanding its US operations. "We have built up a strong presence in the US, with environmental products, weather derivatives and uranium all notable successes last year, and we want to build on that," says an official at the firm.

Tullett Prebon also maintained a strong position in this year's rankings, placing fourth overall in all categories, and ranking first in UK day-ahead and German power. "Volatility across all the sectors saw volumes increase and momentum build," says Andrew Polydor, Tullett Prebon's managing director for energy in London. "There were also a number of new entrants that contributed to the growth in the markets."

The future

Looking ahead to which markets will grow in 2007, one clear theme emerges. "Green is the colour of the next few decades," says TFS' Pinchin.

Both dealers and brokers predict there will be a greater emphasis on environmental products, such as biofuels and emissions. The European carbon emissions market continues to attract large and diverse capital flows, and US businesses now anticipate that some form of domestic carbon trading system will soon come into existence. Banks across the world are exploring the possibilities of biofuels, and both GFI and Evolution Markets have already established biofuels desks.

Finally, in an even more far-sighted move, Spectron has launched an alliance with Denver, Colorado-based information provider TradeTech to help develop a global spot market for uranium.

HOW THE POLL WAS CONDUCTED

Risk received a record 1,400 valid votes for this year's Energy and Commodity rankings. The votes were split between North America (41%), Europe (38%), Asia (17%) and other (4%).

Voters were asked to nominate their top-three energy/commodity dealers in order of preference in categories that they had traded over the course of the year. The voting is not necessarily based on market share - voters could choose various criteria on which to base their choice, including pricing, liquidity and electronic trading capabilities.

Respondents were not allowed to vote for themselves or any subsidiary of their firms, and all responses were checked for validity, with more than 300 votes discarded.

The dealers' votes were weighted, with three points for a first place, two points for a second and one point for a third. The brokers' votes were weighted with two points for a first place and one point for a second. Only categories with a sufficient number of votes are included in the final poll.

The top dealers are listed in terms of overall percentage of votes. The survey also includes a series of product leader boards (oil, natural gas, electricity and metals), calculated by aggregating the total number of votes across individual categories.