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Market Reforms Said to Threaten Hedging

September 21, 2009
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While companies that are primarily financial traders -- i.e., speculators -- are the main target of U.S. Treasury Department and Commodity Futures Trading Commission (CFTC) regulatory reform efforts by the Obama administration, hedgers seeking to manage commodity price risk could get caught in the regulatory crossfire, according to an analysis of proposed reforms by Deloitte & Touche LLP.

If commodities market regulators move more trading to exchanges from over the counter (OTC) markets in an effort to gain more transparency and oversight (see NGI, Sept. 7), the migration could have the effect of reducing hedging options and market liquidity, Deloitte said. The firm is advising its energy industry clients that their businesses could be affected in seven ways:

Deloitte's John England, managing partner for the firm's oil and gas industry sector, told reporters in Houston Thursday that exchange offerings to manage basis risk in natural gas could be much slimmer than what is currently available in the OTC market. "If the intent is to put everything into exchanges...the exchanges only want to support a product that has a lot of liquidity in it. So Houston Ship Channel-to-Henry Hub...it's heavily traded. Somewhere in the Marcellus Shale up in Pennsylvania to the Henry Hub... right now there's not that much liquidity," he said.

Without an active basis market it would be more difficult to value positions that don't involve standard delivery locations. "Today if I try to value a position in the Rockies, I know the value of the position because it's really the basis differential between the Rockies and Henry Hub and then whatever the Henry Hub Nymex [New York Mercantile Exchange] contract is trading for. So I can understand what the value of the position is quite easily. If that basis market starts to disappear or isn't as active, then it's going to be harder for me to value my positions that are in places that are outside of standard traded locations. There's just less price discovery."

And there could even be less trading based in the United States if U.S. regulatory changes create a disparity with other global trading hubs, making those markets more attractive, England said.

"Will we be able to get [regulations] harmonized with other exchanges around the world...That's certainly the intent. They want to do this so that London and other large trading hubs have similar rules," he said. "If they're not able to do that there's a real risk, I think, that you'd see a lot of transactions moving over there. Already I know a lot of the folks I talk to in the trading community have said, 'We can trade gas just as easy out of London or Singapore as we can out of the U.S. It's all pretty much a virtual concept anyhow.' So I think there is some risk that we'd actually have some of that move offshore if we pass something here that then doesn't get harmonized with the other big trading countries."

Cooperative efforts across the pond are already unfolding. Last week the CFTC and its United Kingdom counterpart, the Financial Services Authority, began to work "to enhance cooperation and the exchange of information" to supervise cross-border clearinghouses (see related story).

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