By Christian Berthelsen And Justin Baer 

Trading firm Castleton Commodities International LLC has emerged as the leading bidder for Morgan Stanley's oil-trading and storage business, the latest development in the bank's yearslong effort to jettison the unit.

Castleton, whose backers include hedge-fund heavyweights Glenn Dubin and Paul Tudor Jones, is offering more than $1 billion for the business, according to people familiar with the situation. That number would include the value of assets the unit holds, such as barrels of crude oil and storage facilities.

Morgan Stanley and Castleton are still in discussions, and any deal--if one is struck--is still weeks away. The New York bank has attempted twice before to unload the business, first in 2012 when it couldn't agree on terms with Qatar's sovereign-wealth fund and then in 2014 when an agreement with Russian oil company Rosneft OAO unraveled amid tensions over Moscow's intervention in Ukraine.

Wall Street banks are unloading their physical-commodity operations amid a slump in raw-materials prices and pressure from regulators and politicians. The Federal Reserve has expressed concerns that the dangers associated with transporting commodities pose a systemic risk to the financial system, while U.S. senators have accused banks of unfairly exploiting the multiple roles they play in the market in order to maximize profits.

Taking the place of big banks are privately held commodity-trading firms that operate across borders and face less regulatory scrutiny and lighter disclosure requirements. A sale to Castleton would reinforce this trend.

Morgan Stanley Chief Executive James Gorman has told the bank's board that selling the oil business remains a priority for 2015, people familiar with the matter said. The deal is an important part of his strategy to shrink the part of the firm's balance sheet tied to debt, currency and commodities trading to less than $180 billion by year-end.

The issue has been a key focus during quarterly earnings conference calls with analysts. Morgan Stanley reports first-quarter results on Monday.

Castleton, based in Stamford, Conn., evolved from a spinoff of Louis Dreyfus Commodities Group's energy-trading business several years ago. Its owners include Mr. Dubin, a co-founder of $30 billion asset manager Highbridge Capital Management that was later sold to J.P. Morgan Chase & Co., and Mr. Jones, founder of Tudor Investment Corp. Castleton's chief executive is William C. Reed II, a power trader and onetime executive at Enron Corp.

Castleton's bid topped that of the other contenders for Morgan Stanley's unit, including Australian bank Macquarie Group Ltd. and private-equity giant KKR Inc., according to people familiar with the talks.

Castleton and KKR had previously submitted a joint bid for J.P. Morgan's physical-commodity assets when they were on the block in 2013. That business was ultimately sold to Swiss trading house Mercuria Energy Trading Inc. Castleton and KKR bid separately this time.

J.P. Morgan sold its physical business last year, and Goldman Sachs Group Inc. divested a chain of metals warehouses in December. The Fed is preparing tighter restrictions on banks that trade commodities.

Write to Christian Berthelsen at christian.berthelsen@wsj.com and Justin Baer at justin.baer@wsj.com

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