* Eni keen on doing more hedging, volatility trading
* Barclay looks to repeat refinery supply, capital deals
* Freepoint also keen to provide capital
LONDON, Nov 8 (Reuters) - A decades-old rivalry between banks and trading houses in commodities markets is taking new forms, as banks adjust to tighter regulations and merchant traders mount increasingly sophisticated challenges.
Banks have long been the dominant players in hedging - when commodities producers and consumers buy derivatives to help offset potential sharp price swings.
But as banks recalibrate their exposure to commodities under tight regulator scrutiny, trading houses are looking to grab a share of this business.
Likewise, traders have always dominated physical supply. But banks have been adept at finding niches trades and sometimes even oust merchants by offering supply arrangements together with a wide range of financial services.
"As the market becomes more liquid, especially on natural gas and power, as it becomes more sophisticated in developing specific hedging expertise and volatility trading expertise, the first step is to regain control of our flows," Marco Alvera, Senior Executive Vice-president at Italian oil major Eni told the Reuters Global Commodities Summit.
"This is a very profitable business because not only you save on fees and commissions, but also because you make some interesting money if you monetise this properly," said Alvera, who began his career at one of the most active banks in commodities, Goldman Sachs, in the 1990s.
Trading desks of oil majors such as BP and Shell have traditionally been active in hedging but with the likes of Eni joining the ranks, some top talents are on the move. Two high-profile traders left Morgan Stanley's European desk earlier this year for a trading house.
Eni is the largest gas buyer from Russia, Libya, Norway and Algeria and hedges those activities through fuel oil and crude oil as gas is indexed to those fuels in long-term contracts.
"Typically we would go in the market and just hedge through a third party ...What we do now is that we execute in the market directly without offloading it to a bank," Alvera said.
He said the second step would be to take this activity to Eni's existing customers.
"I would not say we will go to third party customers and offer hedging solutions. But if we have a customer who is already buying a commodity from us, we may as well build the commodity contract in a way that will effectively offer him a hedge or a contract that is more similar to what he needs industrially."
He said that would increasingly become a norm in Italy and southern Europe where gas and power markets were becoming more liquid: "Before some of these guys would just buy the commodity from us and then go to a bank to do their hedging".
MORE CHALLENGING TIMES
Mike Bagguley, head of commodities at Barclays, which alongside Goldman Sachs, Morgan Stanley, JP Morgan and Deutsche Bank is among the most active banks in commodities, said the client flow business such as hedging was indeed slower in 2013.
Part of it was due to lower market volatility.
"People got used to high volatility. Now with lower volatility and in backwardated curve, times are more challenging for everyone in the industry," he said.
Backwardation is when future prices are lower than prompt prices, discouraging consumers from hedging and also making storaging operations unprofitable.
Banks have expanded oil and metals trading aggressively over the past decade but had to scale back in the last few years.
Most of the downsizing happened on the proprietary side, where banks traded with their own money, as regulators said those actions might have added to market froth. JP Morgan said it was looking to sell its physical commodities business.
However banks now offer trading services as part of a mix of capital solutions and merger advice.
Barclays showed such ambitions earlier this year with a deal to supply a Hawaiian refinery. It already has a similar deal with Stanlow, the second-largest British refinery.
As European refineries struggle under low margins and as the cost of capital is expected to increase with the global central bank rate tightening, such deals could be repeated.
"On financing, we have started to get a critical mass. People know that we are capable of executing these deals," said Bagguley. "It works well with the energy markets. It means that banks can help producer clients and also with jobs and the real economy".
As the rivalry between banks and traditional merchants takes new shape, a set of new entrants are adding fuel to the already dramatic commodities landscape reshuffle.
U.S. merchant Freepoint Commodities, launched with backing by private equity fund Stone Point Capital, is also seeking out niche plays, often in the oil sector.
"We find that it's not enough just to participate in some part of the supply chain either by simply being a buyer or seller of physical commodities or leasing assets and providing some sort of distribution function," CEO David Messer said.
"But we actually now find for ourselves and for our fellow merchants that we have our best opportunities come when we can bring capital to a commodity production or to an upstream or midstream development project or distribution project," he said.
(Additional reporting by Julia Payne, Alexander Winning, Simon Falush, Lin Noueihed, Ron Bousso, Dmitry Zhdannikov, David Sheppard in London and Jonathan Leff in New York, editing by William Hardy)