Macaskill on markets: Commodity boom could clash with ESG push

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Goldman Sachs was keen to highlight the contribution made by commodities to its robust recent second-quarter results.

“Strong trading performance was aided by high volumes and volatility across all of our businesses, including oil, natural gas and metals,” chief financial officer Stephen Scherr said on the bank’s earnings call with analysts.

Goldman – in line with other banks – did not disclose how much of its $4.2 billion of quarterly fixed income revenue came from commodities, and Scherr stressed that all five of its debt sales and trading business groups performed well.

Stephen Scherr,
Godlman Sachs

It is nevertheless worth noting that the two US banks with the greatest historical bias towards commodity trading – Goldman and Morgan Stanley – were also the two firms that saw the biggest percentage increases in fixed income revenue in the second quarter.

Goldman saw its fixed income revenue rise by 149% compared with the second quarter of 2019, while Morgan Stanley managed to increase its revenue by 168%, though to a lower overall total than Goldman of $3 billion.

This marked a sharper percentage rise than the two biggest fixed income dealers by revenue, JPMorgan and Citi, as well as outpacing Bank of America and leading European banks.

Morgan Stanley joined other banks in cutting physical commodity trading when it slimmed down its fixed income division in 2015, but remained active in derivatives.

Goldman also reduced its physical commodity capacity but has been the most reluctant bank to make deep cuts to a business line that once produced high profits and helped to propel executives such as Lloyd Blankfein and Gary Cohn to jobs at the top of the firm.

Oil spread

The extraordinary price moves in the oil markets in the second quarter of this year were a driver of a revival in commodity trading revenues for banks, though it is not clear if this boost will last.

The unprecedented move by US WTI oil prices into negative territory on April 20 attracted global attention, understandably.

There were also wild fluctuations in prices and basis levels between different oil reference benchmarks for over a month, however.

Volatility for the nearest WTI futures contract was already close to 150% when the second quarter began and it was still above 200% at the end of April, for example.

The price of Brent oil, the European benchmark, which is not affected by storage capacity considerations for physical delivery against futures in the same way as WTI, also finished April at over 100% volatility for the nearest futures contract.

The spread between Brent and WTI widened as far as a record $63 a barrel on April 20 when WTI prices went negative. The spread retreated to roughly $2 a barrel by May and has been around that level since.

The end of an oil price war between Saudi Arabia and Russia that was bizarrely timed to coincide with the onset of the Covid-19 crisis has combined with a partial revival in global economic activity to underpin and stabilize energy prices.

Other corners

The start of the third quarter has seen increased activity in another corner of commodity trading, however, with both precious and base metals recording sharp price rises.

A move by gold to a new nominal price record of almost $2,000 an ounce in late July was driven by a fall in real bond yields and the value of the US dollar (the reference currency for metals as well as energy prices), along with investor appetite for a hedge against the potential long-term inflationary effects of stimulus measures and the related increase in government debt.

Silver rose sharply for similar reasons and because – unlike gold – it is used in industrial applications such as solar panels that are likely to see increased demand from future green new deal initiatives.

Among base metals, copper is a prime beneficiary of the same trend of expected demand for use in new technologies such as 5G telecom networks and renewable energy.

Copper prices have risen by over 40% since March on heavy trading volumes and are now back above levels seen before the Covid-19 crisis developed pace.

Time to hire again?

So, should banks perform one of the abrupt reversals for which the industry is justifiably famous and start re-hiring commodity traders with generous risk limits?

Probably not, for two main reasons.

One is tactical. The decline in net commodity trading revenues for banks over the last decade reflects the extent to which market-making income can ebb and flow, as well as the effect of regulatory reform.

There has already been a sharp fall in oil trading volumes since prices stabilized in late April and early May, for example.

A fast-moving market throws up opportunities for some stealthy directional position-taking by experienced bank dealers, but proprietary betting when volumes are lower is now discouraged, even at firms that once thrived on risky trading.

The second reason is strategic and reputational.

All big banks now espouse a shift towards provision of more responsible finance, including the endorsement of environmental, social and governance (ESG) standards.

And both trading and financing of commodities bring wide ESG risks.

Recent analysis by Oliver Wyman estimated that the sustainable finance market could develop into a revenue generator of over $150 billion in the next five to 10 years.

This would be driven by ESG investing, at $70 billion to $90 billion; followed by financing activity – such as green lending or underwriting – at $20 billion to $40 billion; and finally, advisory and hedging business at $10 billion to $20 billion.


Commodity trading will always throw up tempting revenue opportunities. Recent reports that Russia is considering adopting an oil-production hedging policy comparable to the one pursued by Mexico for around two decades must have had traders rubbing their hands in anticipation, for example.

Reports that Russia is considering adopting an oil-production hedging policy comparable to the one pursued by Mexico for around two decades must have had traders rubbing their hands in anticipation 

Mexico spends roughly $1 billion a year to hedge against price plunges like the one seen in March and April, and Russia produces more than four times as much oil as Mexico.

So, banks and other hedging counterparties could potentially tap an annual revenue pool of $4 billion or more, just from working with Russia to provide oil derivatives.

Some Russian companies are taking steps towards adherence to ESG standards, often in conjunction with financing from Western European banks that are keen to burnish their own ESG credentials.

But a role as a large commodity derivatives counterparty to Russia might give any international bank pause, even if trades could be structured to avoid sanctions on state-controlled firms such as Rosneft.

Geopolitical risks that include Russia’s attempts to interfere in foreign elections pose an obvious potential reputational threat, in addition to more mundane ESG weaknesses in the country.

There are also many other commodity producing countries where environmental, social and governance problems are rife.

If banks really want to convince their stakeholders that they are serious about embracing ESG principles and shifting towards more responsible finance, they would be well advised to think carefully about the long-term implications of seizing short-term commodity trading opportunities.