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LONDON (Reuters) - Fast-growing trading house Mercuria, led by two former Goldman Sachs (GS.N) executives, has become the front-runner to buy the physical commodities unit of JPMorgan (JPM.N), one of the most powerful oil and metals desks on Wall Street, two sources told Reuters.
JPMorgan decided to sell its multi-billion dollar physical commodities division last year under rising regulatory and political pressure to retreat to the bank's core business of lending instead of speculating in raw materials.
"This week, JPM entered into exclusive talks with Mercuria," one of the sources familiar with the process told Reuters.
The final deal could take a few months to conclude, one of the sources said. If agreed, it would catapult Mercuria into the top tier of trading houses with Glencore Xstrata (GLEN.L), Vitol and Trafigura TRAFGF.UL.
Private and lightly regulated trading houses have benefited most from a major retreat by banks from commodities trading over the past two years.
Companies like Glencore and Russian oil major Rosneft (ROSN.MM) hired whole teams of traders from banks such as Morgan Stanley. (MS.N) But Mercuria could become the first trading house to absorb an entire physical division from a bank.
JPMorgan and Mercuria both declined to comment. A spokesman for Blackstone in London declined to comment. A spokesman for Macquarie in London did not immediately respond.
Mercuria was founded by Marco Dunand and Daniel Jaeggi, who both worked as executives at Goldman Sachs and then trading house Sempra, which was later bought by JPMorgan from the Royal Bank of Scotland (RBS.L).
In less than a decade, Dunand and Jaeggi have built Mercuria into one of the world's largest oil traders, with annual turnover of around $100 billion and 700 traders spread across the globe. But it is still much smaller than the world's largest trader, Vitol, which has turnover of $300 billion.
The deal value has yet to be agreed and will depend to a large extent on the valuation of large stockpiles of oil and metals the bank holds, one source said.
In documents circulated to potential buyers, JPMorgan valued its physical commodity business at $3.3 billion, with an annual income of $750 million. JPMorgan paid nearly $2 billion to buy the largest part of the business from RBS in 2010.
The sale will allow JPMorgan chief executive Jamie Dimon to close the book on a public set-back in a business once hailed as an engine for growth following a dire mix of waning margins, allegations of market manipulation and unprecedented political pressure over its role in the supply chain.
The sale will also raise questions about the future for JPMorgan's commodities chief Blythe Masters, who over the past five years spent billions of dollars building the biggest physical commodity trading operation on Wall Street, surpassing in size long-time giants Goldman Sachs and Morgan Stanley.
JPMorgan has access to a vast global metals trading and warehousing network, a big U.S. power and gas desk and Canadian oil storage leases.
The deal is expected to come with a contract supplying crude oil to the biggest U.S. East Coast refinery, the Henry Bath & Sons Ltd metals warehousing business with about 80 storage sheds stretching from Rotterdam in the Netherlands to Johor in Malaysia, and a sizeable U.S. natural gas and power trading book.
Mercuria has said it is looking to expand in the United States like many other traders as a shale oil boom is opening up new ways to make profits.
"Mercuria have expanded aggressively into new areas of commodity trading in the last two years, and part of that strategy has been hiring some of the best traders from the banking world," said Jake White, head of front-office commodities recruitment at Selby Jennings in London.
"But taking on a business of the size and prestige of JPMorgan's physical business is definitely their biggest move yet, and will undoubtedly propel Mercuria into the top tier of commodity trading houses."
Rising global capital requirements for banks under the Basel III regulatory framework and new restrictions on proprietary trading introduced to prevent a repeat of the 2008 financial crisis have made commodity markets less attractive for many banks.
Commodity income at the world's top 10 investment banks has fallen from a peak of more than $14 billion in 2008 to just $5.5 billion in 2012, according to London-based consultants Coalition.
For many U.S. banks, it was their prime regulator - the Federal Reserve - that delivered the heaviest blow, making clear in recent years that it was increasingly uneasy with Wall Street's expansion into physical trading of raw materials.
Amid negotiations to resolve a host of other regulatory investigations, including the "London Whale" credit losses from derivatives trading in 2012, JPMorgan's Dimon was also stung by a probe into allegations of U.S. power market manipulation ending in a record $410 million settlement.
JPMorgan is expected to retain its basic commodity derivatives trading desk that hedges prices for customers.
While some of the industry's oldest hands such as Goldman Sachs aim to retain much of their commodities businesses, others are getting out or adopting different strategies.
Deutsche Bank announced late last year that it was largely exiting commodities trading, while Morgan Stanley is selling the majority of its global physical oil trading operation to Russia's Rosneft.
Reporting by Dmitry Zhdannikov, Additional reporting by David Sheppard, Oleg Vukmanovic, Henning Gloystein and Veronica Brown; Editing by Peter Graff