A combination of the credit crunch and soaring fuel prices have pushed the costs of letters of credit (L/Cs) used in physical oil trades sky high and forced investment banks to reconsider whether they will continue in what was once a very lucrative business.

At least one major bank involved in physical trading of oil has called a temporary halt to its Asian operations, but even banks that opt for the less credit hungry occupation of trading in oil futures are finding the going tough.

On hold

Morgan Stanley, which has traded physical distillates such a jet fuel and diesel for around 10-years, has reportedly put its fuel oil trading business in Asia on hold.

Morgan Stanley is the only investment bank with an established trading expertise in the physical oil market, and industry sources report that the bank's exit appears more likely the result of volatile market conditions than a lack of expertise or will.

L/C costs soar

Soaring oil prices over recent years means that a 60,000-ton cargo of gasoline now requires an L/C worth US$60 million.

In 2002 a comparable cargo would have needed an L/C worth just US$16 million.

Futures alternatives

Some banks involved in oil trading have avoided capital intensive L/Cs by trading futures contracts with relatively small margin requirements - but even banks involved in derivatives trading are considering their next move.

BNP Paribas has closed its Asian oil derivatives unit in Singapore, while Fortis has shifted its trading team to Houston just months after establishing its operation in Singapore.

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DC-PRO.