Wrong-Way Gas Bet Costs Goldman -- WSJ

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (August 19, 2017).

Goldman Sachs Group Inc. lost more than $100 million in a wrong-way bet on regional natural-gas prices this spring, a setback that played a large role in the New York bank's subpar second-quarter trading performance.

Goldman wagered that gas prices in the Marcellus Shale in Ohio and Pennsylvania would rise with the construction of new pipelines to carry gas out of the region, said people familiar with the matter. Instead, prices there fell sharply in May and June as a key pipeline ran into problems.

Goldman said in July that the quarter ended June 30 was the worst ever for its commodities unit, which has been one of the firm's most consistent profit centers and a training ground for many of its top executives, including Chief Executive Lloyd Blankfein.

The setback extended a broader trading slump at a company once known as Wall Street's savviest gambler. Goldman shares fell 2.6% on the day of the report despite a stronger-than-expected bottom-line profit.

The loss highlights the trade-offs Goldman made in sticking with the risky commodities-trading business, even as other large banks retreated following the financial crisis. Trading oil, metals and other physical commodities is increasingly dominated by less-regulated firms such as Glencore PLC and Gunvor Group Ltd.

Goldman is the seventh-biggest marketer of natural gas in North America, up from 13th in 2011, according to Natural Gas Intelligence -- bigger than U.S. energy giants such as Exxon Mobil Corp. and Chesapeake Energy Corp. It has been the only U.S. bank in the top 20 since 2013, when J.P. Morgan Chase & Co. left the business.

Goldman's key miscalculation last quarter was betting that natural-gas prices in the Marcellus Shale would rise relative to the national benchmark price in Louisiana known as the Henry Hub, the people familiar with the matter said.

Essentially, it was a bet on the timely completion of pipelines under construction to ferry a glut of gas out of the region.

But one of those pipelines ran into trouble this spring: the 713-mile Rover, which would transport gas from the Marcellus to the Midwest and beyond.

Its developer, Energy Transfer Partners, in February bulldozed a historic Ohio home without notifying regulators, and scrambled to finish clearing trees before the roosting season for a protected bat species. In May, federal regulators barred Energy Transfer from drilling on some segments of the route after a series of fluid spills.

The first leg of the pipeline, which had been set to come online in July, isn't expected until at least September. Energy Transfer said it has "been working efficiently and nonstop to remediate" problems and expects to have the entire pipeline operational in January.

The delays in one case quadrupled the market discount on Marcellus gas prices. At one Pittsburgh-area hub, the Dominion South, the Marcellus discount increased from 29 cents per million British thermal units at the end of March to $1.16 on June 16. Prices moved similarly for futures contracts guaranteeing fall deliveries.

Goldman was in part likely catering to gas producers in the region that wanted to lock in steadier revenue through swaps and other contracts. Many Marcellus drillers reported big gains in the value of their derivatives portfolios in the second quarter -- meaning their trading partners lost money in that period, at least on paper.

It isn't clear to what extent Goldman attempted to hedge against possible losses. Hedging is an imperfect science in the best of circumstances, influenced by factors such as weather and trading volatility. It often gets harder and more expensive further into the future.

While the 2010 Volcker rule prevents banks from betting their own money on changes in asset prices, they are allowed to facilitate trades for clients looking to buy or sell. Such "market-makers" play a key role, helping to keep markets fluid and avoid rapid price spirals and panic.

Whether a particular trade complies with the Volcker rule depends on many factors, including who initiated it and how long the bank intends to hold the position.

Goldman has been on the right side of large trades as well. Last year it booked $100 million in gains when one of its credit traders bought beaten-down corporate bonds before prices recovered.

Commodities hold a special place at Goldman. The division, which still operates as J. Aron, a coffee and metals trader that Goldman bought in 1981, gave Mr. Blankfein, President Harvey Schwartz and Chief Financial Officer R. Martin Chavez their starts at the company. J. Aron's $10 billion in pretax profit between 2006 and 2011 accounted for 15% of Goldman's total profit over that period.

"Clients want to buy, so we sell. They want to sell, so we buy," Mr. Chavez said on a July conference call with investors. He added that Goldman "remains committed in every way to help our clients manage their commodity risk."

Write to Liz Hoffman at liz.hoffman@wsj.com

(END) Dow Jones Newswires

August 19, 2017 02:47 ET (06:47 GMT)