Hot Commodity

LONDON – No one comes to this fascinating city for the food. But many, like San Diego-based Sempra Energy, come for the money that can be made here.

While many back home associate Sempra with its San Diego Gas & Electric subsidiary, or perhaps with Southern California Gas Co., another wholly owned utility, commodity trading is Sempra’s most rapidly growing profit source.

Though it only has about 600 of Sempra’s 13,000 employees, Sempra Commodities last year provided 36 percent of the company’s profits, or about $320 million of a total $895 million. The importance of the trading unit was cited as a major reason for Sempra’s decision to hold its annual shareholders meeting this week in London.

Two of the key horses in the company’s commodity trading stable share offices in the financial heart of this old metropolis, in a section itself known as the City of London.

The location is coincidental for Sempra Energy Europe, but key for Sempra Metals Group Ltd., as it is just blocks from the premier market for its products, the London Metals Exchange.

Sempra says the business, with about 100 employees, is a powerhouse in its niche, which primarily involves the trading of industrial metals such as aluminum and copper.

Tom McKeever, the unit’s chairman, said the Sempra Metals Group typically has in storage 20 percent to 25 percent of all the industrial metals regulated by the London exchange.

The puts Sempra near or at the top among traders of most of these metals worldwide.

“We’re probably the second or third largest physical trader,” said McKeever, an American who has spent decades in the business.

This strong position in real inventory, McKeever said, distinguishes Sempra from other players in the increasingly heated metals trading business. Attracted by sharply rising prices, many financial institutions – Merrill Lynch and Goldman Sachs, to name two – also have begun trading.

But most of these financial institutions focus on the paper shuffling end of the business – juggling contracts and financial instruments but avoiding physical handling of the commodity. Sempra is among a smaller group capable of and willing to load trucks and deliver the goods.

With its large warehousing operations, its physical trading capability and its own ability to trade financial instruments, McKeever said, “We’re the only company operating on all three fronts and that gives us a unique window on the market.”

Clients cut their risk

The company’s clients include consumers and producers of the metals eager to shield themselves from price volatility. A producer of copper tubing, for example, who might be reluctant to risk his business or alienate customers with price changes from fluctuating raw material costs is a prospective customer for Sempra. The company can guarantee the costs for, say, 5,000 or 10,000 tons of copper per month from now until the end of the year.

In a typical trading day, Sempra’s London unit closes 1,000 to 2,000 of these deals. The company’s game plan then calls for Sempra to offset much the risk it has assumed by trading, in turn, with other players on the market, McKeever said.

Business for traders like Sempra gets better as prices get crazier, and they have been wild. Copper, for example, which long traded at 60 to 70 cents per pound, now fetches $1.50. The prices are driven by strong demand from China in particular and have sparked investment in mining and production that eventually should boost supply and put downward pressure on prices.

But that is still some time off and not something of great concern to Sempra, McKeever said. He said Sempra can prosper as prices fall, adding that fundamentally, price volatility brings customers to Sempra, as they seek stable pricing and to avoid risk.

“It’s like sailing,” McKeever said. “It doesn’t matter which way, as long as the wind is blowing.”

But the surging prices have brought a flood of speculative investment into the markets. McKeever said metals are approaching the status of an asset class – such as stocks or real estate – and have attracted nontraditional investors such as pension funds seeking to diversify their portfolios.

Sempra is one of just a dozen that sits on the London exchange’s trading ring, which is literally the circle around which deals are done on the floor.

On a typical day at the Sempra office, some 100 traders busily scan multiple computer screens and converse with clients in an array of languages.

Across from the metals group in its glass-walled office, an additional 65 traders work the phones and watchdog their computer screens for Sempra Energy Europe, which trades electricity, coal and natural gas. William Winget, managing director of the energy group, said it’s positioned perfectly to profit from the growing energy deregulation and integration sweeping Europe.

Winget, a Texan, said the European natural gas market is attractive for traders like Sempra, which is already the world’s second largest trader of that commodity. But electricity trading across Europe’s newly integrated electricity grids is the energy unit’s best business now.

“The power business is really wide open now,” Winget said. “We’re probably the No. 5 power trader there now.”

Winget can rattle off the number of competitors who have left the energy trading business in recent years, which includes Enron – from whom Sempra bought its metals groups – as well as Mirant, TXU and others.

Sempra has thrived as others have exited, he said, because it manages risk conservatively, avoiding long-term deals and subjecting its traders to strict daily account controls. Those controls include a daily review of all trading positions at Sempra Commodities’ headquarters in Stamford, Conn., where another 400 people are employed.

The strict control mantra is heard at all levels of Sempra trading – conservative, strict control and limiting trades to reasonably short terms. But similar mantras were heard from many of the firms that failed in the business.

‘We do what we say’

“The difference is that we do what we say,” Winget said.

Mark Snell is president of Sempra’s non-utility businesses, overseeing all trading operations, including an oil trading unit in Geneva, Switzerland, and smaller offices elsewhere in Europe and in Asia.

He says the trading businesses are managed so consistently that they’ve posted profits in 70 of the past 72 months and in each quarter of the past six years.

“Since we bought that business for $200 million, we’ve made $950 million from it,” he said.

The steady record of success has converted some analysts typically fearful of the volatile trading business.

Gary Hovis, a vice president of Argus Research, is among them. He said Sempra sailed profitably through the California energy crisis and the collapse of Enron – once the world’s largest energy trader – as well as some energy exchange glitches.

“Sempra has proven me wrong,” he said. “It’s a matter of strategy and management success and ability, not just luck alone.”

To be sure, Sempra’s success has not come without criticism and some potentially damaging allegations.

Conflict issues raised

The company faces a host of regulatory and legal actions related to allegations of rigging in the U.S. natural gas and electricity markets. And while traders like Sempra insist they provide valuable services to energy users, some consumer advocates challenge the notion.

Mark Cooper, director of research for the Consumer Federation of America, says Sempra’s activities in both the trading and utility businesses raise conflict-of-issue questions, despite the company’s assurances the businesses are kept separate.

Utility companies are charged with providing the cheapest sources of gas and electricity to their customers, a very different mission than an energy trader.

“I don’t need Sempra in the commodity trading market,” he said. “There is nothing they bring to the market but a potential for abuse.”

He added that while supply and demand remain potent forces contributing to the currently high prices for commodities like oil, speculators and traders are also inflating these prices. Those high prices are ultimately paid by consumers.

Frank Partnoy, a professor at the University of San Diego and an expert on sophisticated financial instruments and trading, defends it as a worthwhile business.

“Traders put buyers and seller together, and that is a legitimate business,” he said.

Photo-credit: darkday. via Visualhunt.com / CC BY