As JPMorgan Chase & Co prepares to exit physical commodities trading, the spotlight is turning to the future of the two banks that have dominated Wall Street's involvement in the natural resources supply chain for 30 years.
Goldman Sachs and Morgan Stanley two decades ago became known as the 'Wall Street Refiners' for their mastery of both financial and physical commodities.
But since 2012 Morgan Stanley has looked at selling its commodity arm and Goldman has made moves to scale back its physical operations.
Letters between the banks and the Federal Reserve, received by Reuters under the Freedom of Information Act, show both banks are in discussions on conforming or divesting activities that fall outside the normal scope of commercial banks.
Goldman has been looking at selling its Metro International metals warehouses firm since at least March, but it has also publicly reaffirmed its commitment to its J. Aron commodities business, where CEO Lloyd Blankfein started his career.
Morgan Stanley has been looking at a possible spin-off or sale of its commodity arm since last summer, but with little success. Recent moves suggest it may try to refocus on its vast physical oil trading arm and exit peripheral markets like Australian electricity.
The question is, in part, whether they will be able to choose their own future, or will the Federal Reserve's decision to review the entire role of Wall Street in physical commodities markets see regulators make the choice for them?
The past 10 days has seen unprecedented scrutiny of Wall Street's commodity trade, with a Senate hearing questioning whether banks should be allowed to own pipelines, warehouses and other commercial assets.
U.S. regulators and the Department of Justice have launched initial investigations into the metals warehousing business of banks and other big commodity traders, which have been accused of driving up the price of aluminum by drink can manufacturers.
While JPMorgan cited the growing regulatory pressures as one of the reasons it has decided to exit physical commodities trading, it was not clear if it was influenced by the banks' discussions with the Federal Reserve.
One person familiar with the matter said on Friday the bank had decided the profits from commodities were too slight to be worth the regulatory and reputational risks.
CEO Jamie Dimon has been trying to put the bank back on course after a series of costly trading moves and regulatory run-ins, including a potential $410 million settlement over alleged power market manipulation.
"I don't think it was any one thing, but a culmination of things, that drove (JPMorgan's) decision," said Craig Pirrong, a professor at the University of Houston and expert in commodity markets.
"The legal and reputational risks, the Fed's likely action to constrain - if not eliminate - this sort of trading, the increasing capital strains on banks, and especially the political heat being directed at the industry. In the scheme of things at JPMorgan, commodities just weren't big enough and profitable enough to be worth all this bother."
LETTERS FROM THE FED
Goldman Sachs and Morgan Stanley may hold one advantage over JPMorgan, as their long history of operating in physical commodities as less regulated banks may provide them with "grandfathered" ownership of assets like warehouses, pipelines and storage tanks that other commercial banks aren't allowed.
"I don't think there is a necessary or clear link between whatever the Fed's position is on JPMorgan's ownership of physical assets - if, in fact, it is the Fed that is pushing JPMorgan to divest - and the Fed's position on Goldman and Morgan Stanley," said Saule Omarova, associate professor of law at the University of North Carolina, who appeared at the Senate banking committee hearing last week.
However, there are signs the Federal Reserve is still reviewing this position, just two months before a five-year deadline expires for Goldman and Morgan Stanley to conform their business activities to the Bank Holding Company Act.
A Federal Reserve letter to the Goldman Sachs' lawyers in 2012, obtained by Reuters, said that "specifically, Goldman Sachs continues to engage in commodity-related activities and indirectly controls (redacted) impermissible non-real-estate investments that the Board has not authorized."
The letter, dated September 19 2012, said the Fed was granting another one year extension for Goldman as it had made a "good faith effort to conform its impermissible activities" and had "taken steps to restructure or divest its commodity-related activities and its non-real estate investments."
A Goldman Sachs spokesman declined to comment when asked what assets or activities the Fed letter referred to.
It was not clear if the Fed was referring to Metro International, which Goldman bought two years after converting to a commercial bank during the financial crisis, and is now looking to sell.
Goldman has already got rid of many of the physical trading assets it owned in 2008. Last year it sold its power plant business Cogentrix to private-equity firm the Carlyle Group. Its U.S. power sales have fallen since then, according to regulatory filings with the Federal Energy Regulatory Commission, and are less than one sixth of their peak in 2005.
The bank may choose to focus on financial trading of commodity derivatives and other products, one of its strongest areas. It is already a much smaller player in global crude markets than it was in the 1990s. Oil traders and Wall Street rivals say it is rarely seen moving tankers of crude these days.
Last year it imported 5,000 barrels per day of crude oil to the United States, mainly for a small asphalt refinery in California, U.S. Energy Information Administration data shows. JPMorgan imported 50 times more, or around 250,000 bpd.
Despite launching a metals trading desk in 2010 after its purchase of Metro, it has struggled to compete against big merchant commodity firms like Glencore Xstrata and Trafigura, trading sources say. Two senior metals traders, Scott Evans and David Freeland, left Goldman earlier this year.
Natural gas is the exception, where it has grown from a small presence to be a top 10 physical gas trader in North America since 2010, after its purchase of Nexen's trading book.
Brad Hintz, a Wall Street analyst at Sanford Bernstein & Co in New York and a former treasurer of Morgan Stanley, said that regulatory pressures would probably lead to other banks eventually following JPMorgan's lead.
"The commodities business of the future will likely devolve to its financing and risk management core and the banks will be less active in the physical markets," Hintz said.
"In the vernacular of the commodities market - Wall Street will become "paper" traders."
For Morgan Stanley, the situation may be more complicated.
It went deeper than any other bank into physical oil trading, including acquiring its TransMontaigne terminal and storage firm, which Forbes magazine estimates is the 17th largest private company in the United States, with revenues of more than $14 billion last year.
Morgan Stanley's request to the Federal Reserve for another year's leeway, also released to Reuters by the Federal Reserve under the Freedom of Information Act, consisted of eight heavily redacted pages and 10 annexes. It is not clear what physical commodity assets, if any, have been kept from public view.
A spokeswoman for Morgan Stanley could not be reached over the weekend to answer questions over what non-conforming assets were redacted in the Fed letter, and what, if any, assets had been conformed or divested since.
What is known is that despite all the regulatory uncertainty, TransMontaigne has pushed ahead with one of its biggest physical asset investments ever, taking a 42.5 percent stake in a $485 million oil terminal near Houston.
Two weeks ago, Morgan Stanley tied itself even more closely to TransMontaigne, extending the majority of its oil terminal leases with the firm indefinitely, according to a filing.
The bank remains by far the most exposed to the growing pressure on banks in physical commodity trading.
For JPMorgan's commodity division, it is not clear how the next few months will go. Blythe Masters, one of the most powerful women on Wall Street, will remain in charge of the business and oversee the sale, but Morgan Stanley's experience may suggest it may not be straightforward.
While the bank has already sold more than half of its electricity trading contracts, it still has a vast number of physical deals and assets, including long-term supply and sales agreements with two major U.S. refineries, and its Henry Bath metals warehouse market has over 70 locations worldwide.
In an already crowded market, who would buy its assets?
"I doubt banks will buy. Which only leaves the physical trading houses and some of these newly formed merchant traders like Castleton and Freepoint," said a trader at a Western trading house in Singapore.
But there is one possible alternative.
In 1998, Citigroup said in a press release - reminiscent of JPMorgan's statement on Friday - that it was evaluating "strategic alternatives" for its physical energy unit Phibro, including a possible sale of the company.
The bank had absorbed the big energy trader in its merger with Travelers Group that year, but banking regulations did not automatically allow it to run the business given its dealings in physical tankers of crude oil and pipelines of natural gas.
Five years later Phibro was still a part of Citigroup, and the Federal Reserve granted approval for the bank to carry on trading in physical markets - a landmark decision the Fed says it is now reviewing. That approval opened the doors to almost every other commercial bank on Wall Street getting permission to trade physical commodities over the next five years.
Phibro was eventually sold to oil firm Occidental in 2008, after public outrage over a $100 million bonus Citigroup was set to pay to star oil trader Andy Hall, despite receiving a government bailout.
Pirrong, the professor and commodities expert, said that even if the banks do exit the physical business, they would likely be replaced by other "financial" firms, like private equity groups or hedge funds.
"Finance and commodities are inherently intertwined, and will continue to be so," Pirrong said.
"The identities of the financial firms that are involved may change, but they will perform the same basic functions and provide the same basic products and services that the banks do now."