San Diego-based Sempra Energy announced July 9 it will partner its successful energy-metals trading business with Royal Bank of Scotland (RBS) in a complex $2.65 billion deal that will give Sempra the chance to grow its already substantial trading returns while lowering its risk. If all the regulatory approvals come together as expected on both sides of the Atlantic, Sempra should satisfy any past concerns about its trading role among both shareholders and credit rating agencies.

The joint venture will be called RBS Sempra Commodities LLP and it expects to double its profits over the next five years, with the UK-based bank taking over a majority interest and day-to-day trading operations. Sempra will use RBS’s financial heft, and the Edinburgh-based banking giant will use Sempra’s energy industry acumen.

The transaction is subject to what Sempra called “customary closing conditions and regulatory approvals,” including from the United Kingdom Financial Services Authority, U.S. Federal Reserve Board and the Federal Energy Regulatory Commission. It is expected to close in the fourth quarter.

“The joint venture will be a significant expansion of the activities of RBS’s Global Banking & Markets Division in this important asset class and provides excellent opportunities for further growth,” RBS said in announcing the deal. RBS currently has no energy trading business in its global commodities unit.

RBS Director Johnny Cameron said the joint venture will give the global bank “immediate global leadership in another important asset class that will complement those leading positions.”

Sempra CEO Donald Felsinger said the new partnership will provide Sempra with “unlimited opportunities” to provide expanded transactions that have been limited to it in the past because of Sempra’s relatively small balance sheet. “We’ve basically shed all risk here” in the way the partnership is structured.

Sempra stock closed at $60.74/share, up $1.44, on the day of the announcement and two major ratings agencies affirmed Sempra would maintain its triple-B-plus (“BBB+”) credit rating, according to Felsinger, who spoke with financial analysts on a conference call. Later in the week the price had dropped, closing at $58.62/share last Thursday.

At one point in answering analysts’ questions, Felsinger described the company’s prospects of greater profits with lower risk as being akin to “clipping coupons” for well heeled bondholders.

In addition to trading, Felsinger and other Sempra senior executives indicated that other parts of its business can benefit from its newly created relationship with RBS, one of the world’s largest financial institutions and a leader in financing major energy and natural resource facilities. In addition, Sempra’s vision of trading emissions credits, ethanol and other expected offshoots of the global climate change initiative will be much more feasible with the size and scope of Edinburgh-based RBS.

The global project financing leverage of RBS could significantly help Sempra’s already substantial holdings in North American liquefied natural gas (LNG) projects.

Having grown its trading business into “one of the most successful companies in its sector,” Felsinger said the joint venture will “allow for faster international expansion of our commodities business into new markets, benefiting from RBS’s strong presence in North America, Europe and Asia, and access to greater capital resources.

“With RBS’s additional financial support, RBS Sempra Commodities will expand its leadership position in the commodities sector on a global scale. The new joint-venture structure will provide us with more predictable earnings and cash flows from our commodities business, while eliminating trading guarantees and credit support.”

As a bank, regulated in the United States by the Federal Reserve, RBS is limited in owning hard energy assets (tankage and LNG facilities), so Sempra’s ability to take information from RBS and turn it into infrastructure projects provides the energy company with new opportunities, according to Sempra CFO Mark Snell.

Felsinger emphasized that the combination with RBS on trading will do four major things for Sempra, which has been looking at options for its trading business since the beginning of last year. It will:

In response to an analyst’s question, Felsinger said he didn’t anticipate the level of risk in the trading operations changing dramatically with the new venture and RBS’s obvious deep pockets.

“They like this business and the short-term nature of [our] book, and they like the opportunity of the different types of transactions they can bring to the [trading] business,” said Felsinger, who noted that he doesn’t expect any significant change — just a much bigger platform to work with.

In the joint venture, Sempra will maintain three of seven directors on the board overseeing the newly created RBS Sempra Commodities LLP, and Felsinger reiterated that Sempra plans to be “an active participant,” although the Connecticut-based commodities business will now report to a senior official at RBS in Scotland.

“We have grown this business over 10 years and it provides other benefits to Sempra, so you will continue to see at the board level Mark Snell [CFO], Neal Schmale [president/COO] and myself active on the board, looking at growth opportunities and working hand-in-hand with our new partners at RBS.”

With RBS’s role as a major financing source for LNG facilities globally, there is an opportunity for Sempra to grow further LNG infrastructure in the United States, Felsinger said in response to an analyst’s question.

“When we looked at what the opportunities were for us in this business because it was becoming so successful, when we began searching for partners, we concluded that of all the people we would like to have as a partner, RBS came out No. 1 in the ranking — first, because they are not in the energy business, and secondly, they are such a major financier for the types of projects we have an interest in (energy, natural resources, etc.),” Felsinger said.

“The fact that they have a seat at the table in loaning money to these assets also gives them the opportunity to attract commodity business. People that borrow money are often looking for help to hedge transactions. So they bring to this a lot of upside potential.”

Felsinger at one point called RBS the “world’s leading provider of project finance transactions,” noting it is a complementary strength to the energy trading expertise Sempra has built up over the past 10 years since it bought AIG Commodities, a family of commodity trading companies worldwide whose senior management has evolved from the so-called junk bond-specializing Drexel, Burnham & Lambert in the 1980s to AIG Trading Corp. in the mid-1990s to a part of the newly created Sempra in 1997.

Sempra’s trading operation includes metals based on some acquisitions it made several years ago of European companies, and that part of Sempra Commodities is based in London. Generally its energy trading operates widely throughout the United States, Canada, Europe and Asia.

According to NGI‘s Top North American Natural Gas Marketers for 1Q2007, Sempra Energy was the fourth largest, moving 9.1 Bcf/d. It has a 10-year record of consistently increasing profits, topping off at a half-billion dollars last year, and producing returns averaging about 20% annually, according to Schmale, speaking May 31 at the Deutsche Bank Energy & Utilities Conference.

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