Exchange giants take their rivalry to Texas as shale oil boomsBy Gregory Meyer in New York and David Sheppard in London | February 12, 2019
The world’s two biggest energy exchanges have taken their fierce rivalry to Houston, Texas in pursuit of business linked to the millions of barrels of shale oil arriving in the city every day.
Last last year, exchange operators CME Group and Intercontinental Exchange introduced duelling futures contracts that track the price of West Texas Intermediate crude as delivered at the coastal city.
The battle between the contracts — dubbed WTI Houston and Permian WTI — is a reflection of Houston’s growing status as an energy trading hotspot, as US oil production breaks records, Texas refineries add capacity and exports of crude soar.
At the moment, oil markets in the Gulf coast region lack widely traded derivatives contracts, which is a potential problem for companies trying to hedge risks. Contracts culminating in physical delivery at Houston would be a purpose-built tool which reflect the city’s emergence as a gateway between domestic and international markets, exchange executives say.
At stake is the chance to own the next major oil contract that some believe could be a major money-spinner for the two exchanges. CME of Chicago and ICE of Atlanta have earned billions of dollars in revenues since establishing the world’s two main oil benchmarks — WTI and North Sea Brent, respectively — three decades ago.
"US barrels are going to become more and more relevant to global oil flows.” Jeff Barbuto, global head of oil marketing at ICE.
“This is not our average contract launch,” says Jeff Barbuto, global head of oil marketing at ICE. “US barrels are going to become more and more relevant to global oil flows.”
Exchanges owned by ICE and CME have competed in crude oil futures since the 1980s. ICE’s Brent crude benchmark is based on North Sea supply. CME’s light, sweet WTI benchmark is delivered to the storage hub of Cushing, Oklahoma — a small town about 500 miles north of Houston.
At times, the price of oil at Houston disconnects from prices in the North Sea, Cushing or both, suggesting the new contracts could be useful to companies selling oil there. Volumes have picked up in recent weeks.
“We are following the lead of the commercial customers that are telling us both with their investments and with their marketing where they need risk management,” says Peter Keavey, CME’s global head of energy.
The contracts present somewhat different opportunities for each exchange group. At CME, Houston trading complements its flagship oil contract. “The key benchmark is still WTI-Cushing,” Mr Keavey says.
For ICE, Houston is a potential beachhead in the US crude oil market, where its main contract is a “lookalike” that tracks the price of CME’s WTI. “ICE would love this to be a giant contract,” says Campbell Faulkner, chief data analyst at OTC Global Holdings, a Houston-based energy broker.
Academic research has shown that new futures contracts are likely to fail unless they are substantially better at reducing risks than existing futures contracts, says Hilary Till, principal at Premia Research in Chicago.
She cites the economist Holbrook Working’s conclusion that commercial traders would choose an imperfectly tailored futures contract — such as WTI-Cushing to manage risks at Houston — if it protected them against extreme losses, and if the cost of entering and exiting the market were small.
CME’s WTI-Cushing and ICE Brent are already deeply traded markets with daily volumes hundreds of times higher than the Houston contracts.
“The history of well-designed futures contracts not gaining traction is very long,” Ms Till says.
The new CME contract is delivered at Houston terminals owned by Enterprise Products Partners. Its rules require oil with gravity, or density, that measures within a narrow band of 40-44 “degrees”. The oil may contain no more than 0.275 per cent sulphur content and four parts per million of the metals nickel and vanadium.
ICE’s contract is delivered at Houston terminals owned by Magellan Midstream Partners, whose specifications allow oil with a wider gravity band of 36-44 degrees and a sulphur cap of 0.45 per cent.
“We have a tighter spec,” CME’s Mr Keavey says.
ICE, however, has been publishing monthly average readings of gravity, sulphur and metals to demonstrate the consistent quality of the WTI underpinning its contract. The unblended crude is tapped from pipelines running straight from oilfields in west Texas’s Permian Basin, according to the exchange company.
“We're really betting that quality control all the way from the wellhead to the water is going to make the difference,” Mr Barbuto says.
Dennis Sutton, executive director of the Crude Oil Quality Association, an industry group, says ICE’s reports “could lead me to believe that it is better quality,” but he noted that the figures were averages which could mask day-to-day variation.
“If I had crude buyers asking me which ones should I buy and how much should I pay, I’d need to run the numbers through more sophisticated linear program models to come up with the answers,” says Mr Sutton, a former Marathon Petroleum executive.
The push to establish a Gulf coast crude oil price standard comes as S&P Global Platts, whose North Sea price assessments form part of the physical trading market, is examining whether to incorporate other light, sweet oil streams into its daily snapshots of the north-west European market.
This could include the light US crude oil captured by the Houston contracts, with Platts noting it has seen “regular trade flow” from the region. The Platts Dated Brent benchmark is intrinsically linked to ICE Brent futures, which together help form reference prices for the majority of the world's seaborne crude trade.
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