A new wind will start blowing in the US energy
derivatives market later this year, when the Commodity Futures
Trading Commission is expected to announce position limits and
set a date for their implementation. But so far, no one knows
how cold that wind will feel, or in what direction it will
drive the market.
The Wall Street Reform and Consumer Protection Act, signed
into law in July, hammered home the CFTC’s
responsibility to set energy position limits, a job hitherto
delegated to the exchanges. But the details of the limits are
still anything but clear.
As many contacted for this article acknowledged, including
those for and against limits, it is only when the full terms
are known that the impact can be gauged.
Fears that CFTC position limits will drive the US energy
markets overseas are probably vastly overblown. But at least
one foreign exchange is watching the limits carefully, and
depending on what is decided, may position itself to siphon
business away from CME Group’s New York Mercantile
Alain Miquelon, president of the Montreal Exchange, told FOW
that US position limits could have an impact on what contracts
it decides to launch. "The details announced in the US will
play a role in deciphering where we put our focus," he said.
"Right now, we are waiting to see how the regulations pan
On June 18, Montreal Exchange launched Canadian Heavy Crude
Oil Differential Price Futures, known as WCH. They are designed
to help customers hedge the risk involved in buying and selling
Canadian-produced heavy crude, a newer blend that is different
from traditional crude and therefore priced differently. "Heavy
crude is traditionally priced at a discount to WTI, so the WCH
allows the producer and the other interested players to hedge
that differential," says Miquelon.
Any future moves by Montreal to list futures on broader
North American oil or gas types could also be influenced by the
CME’s decision to step on to its territory. The
CME launched a Canadian Heavy Crude Oil (Net Energy) Index
Futures contract (WCC) in late July.
Part of the attraction for rival exchanges is that the
CME’s crude oil derivatives have had a busy year
so far. The Nymex Light Sweet Crude Oil contract (WTI) had a
record trading day in April.
"The return to activity in many of the energy derivatives,
including oil and gas, is driven by the need to hedge risk in
the marketplace. So as price volatility returns, so does the
need for hedging against that price volatility," says Joe Raia,
CME’s managing director of energy and metals
products and services.
Walter Zimmermann, chief technical analyst at United-Icap,
energy analysis arm of the interdealer broker, gives a
different reason. Participants who stopped trading the sector
after the financial crisis are coming back to the fold, he
says. "Before hedge funds were hit during the financial crisis
and many shut down, they had been one of the biggest sources of
growth in energy derivatives for some years."
lose their appetite
Natural gas futures traders
have been shocked by a recent shake-up in market
fundamentals, leading to partial backwardation.
Contracts for August
delivery were priced higher than those for September
– a pattern that goes against the grain. Now,
October futures are trading around the same price as
September contracts – not higher, as is
Richard Goozee, a natural
gas trader at New York-based Arctos Capital, says these
shifts signal a deep-seated change. "The end of summer
is when people usually inject increased amounts of
natural gas into storage, but this year they are not
– even though storage is by no means full," he
says. "The only explanation is that the long term
demand outlook is drastically lower than what was
According to form, natural
gas futures should be getting a lot more expensive at
this point in the calendar, but instead, cash and
futures prices are falling rapidly. "Right now, people
are delivering natural gas for a price much lower than
what they sold futures contracts for through August,"
says Goozee. 'They obviously do not believe that the
prices will go back up before delivery in the winter
The US Energy Information
Administration reports a weakening of the natural gas
storage curve in the last couple of months – a
weakening that is expected to continue.
Antoine Halff, head of
energy research at Newedge, believes natural gas
fundamentals have changed in a way that is likely to
keep futures prices at moderate to low levels, by
"For many years,
conventional wisdom was that US domestic production was
declining and that consumption was increasing. But
those two assumptions have been overturned in the last
few years," says Halff.
Just a couple of years ago,
people were trying to work out how many terminals the
US needed for importing liquefied natural gas. Dozens
of projects were on the board. Now it turns out that
the country doesn’t need any liquefied
natural gas, says Halff.
Even with a serious upswing
in the economy, the outlook for natural gas will be the
same. "While oil derivatives have sewn their fate to
the stockmarket, rising and falling as if in tandem,
the price of natural gas derivatives have the burden of
fundamental oversupply and a changing industry to
overcome," says Walter Zimmermann, chief technical
analyst at United-Icap in Jersey City. "It would take
one heck of an upsurge in the economy to be able to
absorb the gas coming to the market."
According to Antoine Halff, the head of energy research at
Newedge in New York, it is not only pre-crisis participants
that are stimulating activity in oil derivatives, but
pre-crisis issues. "In oil in particular, fears of runaway
demand and supply constraints, which were popular themes
through to July 2008, have reasserted themselves in the market
this year," says Halff. But, he points out: "There is a lot
more supply than a lot of people expected while the recovery in
demand is not as compelling."
As participants return to oil derivatives markets,
established exchanges are seeking to protect their market
In an April letter to David Stawick, secretary of the CFTC,
CME Group’s chief executive Craig Donohue points
out that "no other foreign jurisdiction has demonstrated an
intention to impose position limits".
The exchange believes its self-imposed caps on positions are
already very restrictive. "We have a lot of experience managing
position limits against our futures contracts and our OTC
contracts," says Raia.
Many argue that the government is always the last ambulance
on the scene of the accident, and that position limits should
not be the prime concern in an economy where the recovery is
"Nevertheless, with or without position limits, if someone
wants to put on a big position, they are going to find a way to
do it, even if it means going outside the US-based commodity
exchanges," says Zimmermann.
A multipolar world
Already, several exchanges around the world have dipped
their toes into the oil and gas market, providing new variety
to firms wanting to hedge prices or speculate on them. And for
most of these, the game is not about sucking business away from
New York or London, but creating new activity.
Among them are the Dubai Mercantile Exchange, with its
Oman Crude Oil Futures, and
the Dubai Gold and Commodities Exchange, which lists WTI and
Brent Crude Futures.
At the end of August they will be joined by the
Singapore Mercantile Exchange, offering Brent in euros and WTI
in dollars. Also preparing to launch is Hong Kong Mercantile
Exchange, which plans to list jet fuel futures (see
separate article on Asian commodity trading).
The DME, which is regulated by the Dubai Financial Services
Authority, outsources its clearing to CME ClearPort, and
therefore abides by US position reporting requirements.
Even though there would appear to be no requirement for a
Dubai-regulated exchange to comply with US position limits, any
advantage from ignoring them would be negligible, says Thomas
Leaver, the DME’s chief executive.
Oman Crude, the largest physically delivered oil contract in
the world, differs substantially from futures at the CME and
ICE Futures Europe, not only in its delivery but also because
it caters specifically to those wanting to mitigate risk
associated with oil and its producers east of the Suez canal,
"There will be no advantage to us if the US imposes position
limits because we offer a relatively specific product that is
not in direct competition with other contracts offered
elsewhere," he says.
The DME has slated four more oil derivatives for launch
later this year: Oman Calendar Swap, Brent-Oman Calendar Swap,
Oman Average Price Option and Oman European Style Option.
Similarly, Eric Hasham, chief executive of DGCX, says that
his exchange is not trying to win clients away from markets in
the US or around the world, but simply to cater to the
substantial demand in the Middle East. Currently, almost 85% of
the exchange’s volume is from the region, with
participants from Europe running a distant second.
Halff at Newedge believes that, whether or not some US
trading ends up moving offshore to escape positions limits,
there is anyway a significant need for more oil derivatives to
be brought to market.
"The rise of new markets will create arbitrage opportunities
that will not undermine the existing contracts, but create new
strategies," he says. "As new oil blends come on to the market
and regional demand in places like China continues to grow,
people will want to be able to reduce the associated risk."
Encouraging words for those new and start-up exchanges
– and for traders, wherever they are.