At the once-feared commodity trading arms of Goldman Sachs and Morgan Stanley, the pressure to do better in the second half of this year has never been more intense.
Long admired for their scale, savvy and unrivalled expertise that lifted them leagues above rivals, the two investment banking titans on Wall Street reported last week a significant drop in commodity revenue in the second quarter.
Subpar trading results have left the door open for others to muscle into the turf they have long dominated, and now JPMorgan Chase is challenging them as the dominant commodities firm on Wall Street.
Commodities usually account for a relatively small share of trading income at Wall Street banks, compared with equities, currencies and bonds. But at Goldman and Morgan Stanley, they can make up as much as a tenth of their multibillion dollar profits.
But by singling out the business in the second quarter, the two showed how much commodities had weighed on their bottom line, and led some to question whether the glory days of Goldman's J. Aron franchise and Morgan's vast physical oil empire may be over as the heat of intensified competition and tougher regulation catches up with them.
Meanwhile, JPMorgan, which used to trade mostly metals before pushing into oil three years ago, could pick up top place in commodity revenues as a series of risky acquisitions and hires start to pay off. The bank is reported to have enjoyed bumper commodity revenues in the second quarter that bolstered its overall results.
While one quarter does not a trend make, a close examination of Goldman and Morgan Stanley's results shows their quarterly commodity revenues shrank more often than they grew since 2008.
"The pedigree that was once the almost exclusive constituency of Goldman Sachs is now being more evenly spread out," said Oliver Pursche, president of Gary Goldberg Financial Services, who manages a commodity mutual fund and holds stock in both Goldman and JP Morgan.
Initially dismissed by some as the result of less risky trading ahead of a regulatory crack-down, revenues are now eroding even as both banks put more of their own funds in play while also expanding into less glamorous commodity related businesses that don't require as much leverage or capital.
According to a study conducted by Reuters of 10 quarterly statements since the start of 2009, Goldman reported its commodity performance was down or flat year-on-year six times; Morgan Stanley only mentioned the sector positively three times in that period.
LONG TIME COMING
JP Morgan, alongside other major banks like Barclays, have been fighting to score a slice of the lucrative trade as investor interest in commodities soared.
A report by Greenwich Associates earlier this year said JP Morgan had built the largest over-the-counter energy derivatives business, with penetration of 41 percent of the major firms in the market, compared with 39 percent for Goldman. Morgan Stanley tied with Barclays at 38 percent.
The shake-up in the pecking order stems as much from a struggle within the top two companies to transform commodity arms that combine trading for themselves with client business -- a delicate balance that has been under growing scrutiny from both regulators and customers -- as from tougher competition.
John Fay, Global Head of Fixed Income, Currencies and Commodities (FICC) at NewEdge, one of the world's largest brokers, said investors had become increasingly wary of using the services of banks that also trade their own books after a series of scandals during the financial crisis.
"If you're running a hedge fund, do you want to be giving all that business to someone who's competing with you?" Fay said. "(Goldman and Morgan) are running very similar strategies."
Goldman Sachs shocked markets last week by reporting its FICC trading arm earned just $1.6 billion dollars between March and June this year, the worst result since late 2008.
Morgan Stanley's FICC at $2.1 billion was up $200 million from the first quarter but down $300 million from a year ago. The bank said its commodity business shrank in the second quarter due to weak client activity.
While Goldman reported that overall risk was down, its commodities-related Value-at-Risk (VaR) -- normally the only specific figure published by banks on their commodity trading, measuring how much money they could potentially lose on an average day -- was above the recent norm.
Goldman's VaR between January and June averaged $38 million a day, the highest since the first half of 2010. Morgan Stanley's averaged $31.5 million, the highest since before the financial crisis. By contrast, JP Morgan scaled back risk to an average of around $14.5 million over the same period.
In the latest quarter, JP Morgan, smashed expectations for its FICC arm. The bank has made almost $9.5 billion in FICC trading in the first six months of this year, results tracked by Reuters show, almost matching the combined FICC revenues of Goldman and Morgan Stanley. Partly that's down to commodities.
JP Morgan's commodity business has grown from around 125 employees in 2006 to 1,800 today. JP Morgan bought the commodity arm of Bear Stearns during the financial crisis and RBS Sempra last year, as well as making some high-profile hires, including former Goldman trader Jeffrey Frase to run its oil desk.
According to a Wall Street Journal report last month, commodities earned around $750 million of JP Morgan's FICC revenues in the first six months of 2011, with the energy sector proving particularly profitable.
CAN GOLDMAN AND MORGAN STANLEY BOUNCE BACK?
But trading performance in commodities can be cyclical, like the markets themselves. Commodities have been volatile enough in the past two years to prove that one-way bets are a thing of the past. Reinventing the business may have become more important than ever.
JP Morgan made some high profile stumbles in 2010, including losing over $100 million on one coal trade that went disastrously wrong. Blythe Masters, head of commodities at the firm, was forced to go in front of the board to defend her position with some tough targets in place for this year.
While the bank looks well on its way to hitting the $1.2 billion target Masters was handed this year, according to the Journal report, it fell well short in 2010, earning just half that amount.
Goldman and Morgan Stanley may have the firepower and strategy to stave off further encroachment by their rival.
Last year, while JP Morgan was busy with the takeover of RBS Sempra's commodities business, Goldman bought Metro International, a warehousing company in Michigan, jump-starting a lucrative physical metals trading operation. And Morgan Stanley has developed a significant index-sales business.
"Really, the proof of the pudding will be in the next quarter," said Matt McCormick, a banking analyst at Bahl & Gaynor in Cincinnati, Ohio. "The expectations will probably be that Goldman gets better at bat this time. We'll see."