Flipping homes. It seems to be all the rage on TV these days. Flip or Flop. Flipping Las Vegas. Masters of Flip. You get the idea.
While the concept of flipping (buying an existing home at a very low price, improving it, and then reselling it for a profit) isn’t new, after the economic downturn and the associated real-estate depression, flipping has become a popular business model for some real-estate oriented operators.
And while energy traders don’t necessarily rip out carpet, install granite countertops and new subway tile, the basic concept is still the same: Buy it low, sell it high, reap the rewards.
Specifically, the flavor of energy trading we’re talking about here is speculating, rather than hedging.
Speculating is when Flip or Flop’s Tarek El Moussa goes to an auction and buys a rotting, flea-infested home sight-unseen on a gut feel and then his (soon-to-be ex-)wife Christina manages to turn the disaster into a profit.
Hedging is when Fixer Upper’s Chip and Joanna Gaines find a decent deal on the market with good potential and invests a couples’ money into it, knowing that the end result will be an asset worth more than the couple invested.
Ok, I’ll agree those are some pretty sketchy comparisons, but I think you get the idea. In an effort to redeem myself, I’ll let the U.S. Commodity Futures Trading Commission describe it better by defining a speculator as “a trader who does not hedge, but who trades with the objective of achieving profits through the successful anticipation of price movements”.
On the flip side (no pun intended), the practice of hedging can be described as taking an offsetting position in a derivative to balance any gains and losses to the underlying asset.
Ultimately, while speculating tends to engender a feeling of risk-taking, hedging attempts to do the opposite by trying to eliminate the volatility associated with the price of an asset.
In the recent past, speculating was a popular practice in the financial industry, but most financial institutions have scaled down or abandoned their commodity trading businesses over the past few years as regulatory scrutiny continues to pressure them to minimize their exposure to energy commodities.
To make matters worse for banks that have continued to play in the energy commodities trading business, this past month the Federal Reserve proposed new rules that could drive banks out of the business of owning, trading and moving certain commodities.
If the Fed has their way, the proposal would force them to do more to protect themselves against environmental disasters that have the potential for huge liabilities in the form of requiring them to hold billions of dollars of extra capital in their physical commodities businesses.
It’s that feeling of “risk taking” that’s kept some of the major energy companies out of the speculation business. But with the energy markets still somewhat in the tank, speculating on energy commodities has more than a few revisiting the practice.
Large energy companies with trading divisions such as BP, Shell and Total have earned significant profits during the energy downturn, and that has companies such as Exxon Mobil evaluating the possibility of establishing a trading division for crude and refined products
However, at risk averse companies like Exxon, the concept of pure energy speculation for profit most likely will face some opposition from some corners of the company that consider opportunistic trading in conflict with Exxon’s conservative culture.
But cash is king, and with the bumper crop of profits that BP, Shell and Total’s trading divisions have brought in, along with significant trading operations at companies like Vitol, Trafigura and Mercuria, it’s become exceedingly hard for Exxon management to continue to turn a blind eye towards another potential revenue stream.
Additionally, a rumored changing of the guard in Exxon’s senior management has come sooner than expected with CEO Rex Tillerson being announced as Trump’s new Secretary of State. Exxon, in turn, has just announced his replacement, company president Darren Woods, who, speculation has it (again, no pun intended), is much more open to the idea of breaking tradition and embracing a trading division.
If Exxon does eventually embrace speculative trading in a big way, they could potentially become Big Oil’s next “Master of Flip”.