Energy and Banking Collide

Location: New York
Author: Lenny Broytman
Date: Wednesday, July 11, 2007
 

Two entities within the energy and banking sectors are on a course to collide in a collaboration that both parties hope will prove to be a lucrative one. The venture set to take place will be between Sempra Energy and the Royal Bank of Scotland Group PLC (RBS) in what appears to be a joint venture for commodities trading.

The Wall Street Journal reports that Sempra, who is currently looking to expand, plans to take advantage of the bank’s deep pockets and excellent credit rating in order to try and do just that.

“Counterparts didn’t look at us as big enough,” in order to complete substantial transactions, said Donald Felsinger, chief executive of San Diego-based Sempra. “This will take us to the next level.”

RBS is taking its first steps into the commodities game and with that, will be able to assist Sempra with its plans for expansion with the use of more complex deals such as one entity that would supply fuel to a power plant in exchange for the plant’s output. It is an arrangement that will be designed to hedge both gas and electricity prices.

In a note that was issued yesterday, Fitch Ratings reported that the future venture will enable both of the entities involved to compete for a fairly large chunk of the energy market. Despite this, the report also mentioned that the deal may have a hard time retaining traders. “As the new manager, RBS will have to establish oversight while keeping the existing traders at a time when top-tier energy traders are in high demand,” added the report.

Sempra is slated to pour $1.3 billion of existing equity into the venture, with RBS contributing an additional $1.35 billion. The newly-formed venture will be known as RBS Sempra Commodities LLP and will be fueled mainly by RBS capital in the future.

Both parties are slated to receive 15 percent returns on their initial equity investments. It has been reported that Sempra is set to receive a vast majority of all initial profits, bagging an estimated $350 million of the next $500 million in profits after the initial 15 percent return. RBS will receive only $150 million at that interval but stands to receive 70 percent of everything made beyond that point. Published reports suggest that in order to hit that higher tier, RBS will be forced to expand beyond its 2006 pretax earnings of $800 million.

Executives at Sempra are hoping that the venture will loosen up nearly $1 billion in capital, which can be used to repurchase shares of stock and increase its dividend. The company’s current outlook is that the plan will raise their stock’s price two percent and will offer returns of 35 to 40 percent of future earnings in dividends.

Just this past March, Johnny Cameron, the chief of RBS’s corporate markets business, said that commodities were always a pretty vital part of the bank’s annual revenue, making up about 50 percent of the bank’s profits.

Sempra Energy, which owns several US-based energy entities (including California electric and gas utilities, pipelines and liquefied-natural-gas facilities), got involved in energy trading roughly ten years ago. They settled into the sector just as US markets were undergoing deregulation. The firm isn’t in the same league as some of the larger players in the commodities sector but has done a decent job of competing with powerhouses such as Morgan Stanley and Goldman Sachs Group Inc. Just five years ago, the company acquired Enron Corp.’s London-based metals-trading business. Up until this point, the company has been limited to fairly small, short-duration deals due to its BBB-plus credit rating.

With RBS’s help, the company hopes to become a much larger presence in the energy market. For RBS on the other hand, the firm hopes that the venture will help to throw a few hedge funds their way which, because of the market’s volatility, have often proved to be quite lucrative for many investment banks.

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