Commodity oddity....Citi loses the energy to trade

There's an old investment adage that says 'run your winners and cut your losers' – a refreshingly simple concept for an industry that often does its best to confuse and befuddle. Lately however, this truism has been challenged by the two words that will terrify even the most hardened of bankers – 'executive compensation.' Citi's decision to sell Phibro, its energy trading division, has clearly been motivated by little else than regulatory pressure.

Phibro is a consistently profitable business (I know, how many can say that these days?) that has netted Citi around $371m a year in annual earnings over the past five years. This, as Anthony Currie of breakingviews highlighted: "equates to a profit margin of more than 50%, and has been a bright spot in the last couple of years as Citi posted billions of dollars in losses elsewhere." Granted, Phibro is not a huge business given the monolithic scale of Citigroup. Nevertheless, profits are profits and it was nice to see that a division could stand strong while the rest of Citi's edifice seemingly crumbled.

Occidental Petroleum, the energy and chemical giant, picked up Phibro for just $250m, which many market observers have described as "a pittance" considering the profits it once netted the bank. That said, the sale is not exactly a surprise given Citi's political and economic situation: a troubled bank propped up by the US taxpayer, an obligation to pay star trader Andrew Hall a whopping bonus of $100m, and a government that has executive pay firmly in its sights. Not exactly peaches and roses for the folks at Citi. So, to be fair to their embattled CEO Vikram Pandit, the pressure to hive off Phibro was so overwhelming that to do otherwise would have been untenable.

It's not actually the sale of Phibro that's alarming, as it was undeniably a forced hand, but rather the political machinations that promoted the sale. We all know the era of light touch regulation is behind us but politics and economics don't often make good bedfellows. In a fiery research note from Rochdale Securities' Richard Bove, dramatically titled "Socialism in Action", he argues that the sale does not make good business sense. Bove says the decision was not in the interest of the Citigroup shareholders and "also sets the pattern of what may prove to be a series of similar actions by other banks reacting to the government takeover of the banking industry." It's this aspect, rather than his socialist rant, that's of note and as FT's Alphaville concludes: "the regulatory environment for banks, and the government's tolerance for the high-risk, high-reward model of years past, is changing and not necessarily in what some bank-shareholders see as their interests."

The whole affair also throws the spotlight on the world of commodities trading and the growing band of non-financial players, including producers, dedicated commodity trading houses and utilities, who play an increasingly influential role in the energy trading markets. Many of these companies can dominate sectors of the energy markets, derivative as well as physical, without the same transparency and scrutiny that a bank is under.

Occidental's purchase of Phibro is illustrative of a wider shift in the commodities business and as the FT describes: "the latest episode in an exodus of specialised commodity trading talent from banks coping with greater government say over compensation." After all, why stay at an investment bank and face the constant ire of regulators when you can quietly trade elsewhere and continue to pick up huge pay packages. The FT says that "we live in Financial Times" – more like strange times if you ask me.

JS