A gang of heavy-hitters hopes to take global over-the-counter(OTC) trading of energy, metal and other commodities to a whole newballpark — the Internet, where liquidity is expected to be big.Last week’s announcement of the plan was followed by a relatedupset of Nymex board members and speculation that others will befollowing the group’s lead.
Seven U.S. and European financial institutions and diversifiedenergy and natural resource firms are launchingIntercontinentalExchange, an Internet-based marketplace toinitially trade oil, oil products and precious metals, with gas andelectricity to come later. The venture is backed by $20 million inequity investments by the partners.
The partners are BP Amoco, Deutsche Bank, Goldman Sachs, MorganStanley Dean Witter, Royal Dutch/Shell Group, Societe Generale, andthe Totalfina Elf Group. Based in Atlanta, the venture intends tobegin trading in a variety of petroleum and precious metals-basedOTC products later this year with plans to later develop additionalmarkets for other commodity products, including global natural gas,electrical power and a variety of base metals.IntercontinentalExchange officials would not say when electricityor gas trading might begin.
There will be no “memberships” in the exchange and no dues orfees beyond those incurred in the process of trading. Participationwill be open to all commercial market participants, providing theycan clear credit requirements with trading partners.
Neal Shear, managing director of Morgan Stanley Dean Witter,said initially the service will be used by large metals and energymarket participants trading with bilateral contracts. Creditrequirements are expected to be high.
IntercontinentalExchange will compete with EnronOnline, whichwas started in October. Unlike the Enron model, Intercontinentalwill offer a choice of multiple sellers. Shear said his group’sbusiness model will generate more liquidity. “We think that theirmodel, one person [Enron] serving many, is not the right model. Wethink that many [sellers] serving many [buyers] is the right model.This system will be open to as many participants that want to playin this space… We think that the liquidity will be significantlybetter on a business model like this.” Enron did not make anyoneavailable to comment.
The seven founding firms, which are to provide the initialmarket liquidity to IntercontinentalExchange, are among the largestplayers in a broad array of OTC commodity products.
The $20 million financial commitment from the seven partnerswill help pay for setting up offices worldwide, saidIntercontinentalExchange CEO Jeffrey Sprecher. However, thefinancial contribution of the partners is secondary to the marketclout they bring and the liquidity that is expected to create. Forexample, the top two or three spots in league tables for principalsin nearly every category of OTC energy derivative products are heldby the founding participants of IntercontinentalExchange. This willoffer market users heretofore unmatched access to the liquidityprovided by these significant market players.
Still, competition is expected to be fierce. Sprecher told NGIhe expects systems vendors to be putting together groups in variouscommodity areas. Also, existing commodity exchanges may move intothe OTC space, and still more heat could come from trading systemsin other fields, such as financial and interest rate products. “Ourgoing public with this group may unfortunately split the market…We may have sort of unwittingly also spawned additionalcompetition.”
Sprecher tipped his hat to Altra’s Altrade andHoustonStreet.com, saying the two systems “so far have done areasonable job of lining up traders.” Altra did $1.65 billion in11,000 gas and power transactions in February. WhileIntercontinentalExchange is definitely on Altra’s radar screen,Chairman Rusty Braziel said his firm’s biggest competition comesfrom established electric trading powerhouse Bloomberg.HoustonStreetExchange initially went live in selected markets inJuly and then nationwide in September. It currently trades physicalpower, plans to add financial power next month and platforms forcrude oil and refined products in May. Spokeswoman Kim Salem wouldnot disclose volumes traded. “Every month it increases, and it’sdoing well.”
The Internet-based energy trading platform industry hasexperienced some consolidation of late. Last month, Houston-basedAmerex Natural Gas Inc. and sister company Amerex Power Inc. boughtthe gas and power brokerages of Houston-based BTU Brokers for anundisclosed price (see NGI March 6). Last year, Altra bought threedifferent online brokerage firms, including its chief competitor,QuickTrade (see NGI Jan. 18, 1999).
“I believe that, just as financial products have quickly andefficiently moved onto electronic trading platforms, so too willcommodity products,” Sprecher said. “Energy and metals are anatural start, but not an end to this venture. My own experiencesin the natural gas and electricity markets and my understanding ofother established and emerging commodity markets suggest thatgrowth for this method of trading will be exponential.
“I think ultimately traders are going to go where there’s goodvolume and trade execution… Our hope is that we can do that overa broad array of products. I think it’s fair to say the markets maysplit along product lines… Generally speaking, our sole focus islaunching with a lot of volume on the first day.”
The New York Mercantile Exchange (Nymex) was approached byMorgan Stanley and Goldman Sachs for participation in the Internetventure but declined the offer, concluding that the platform is”not fully consistent with its own strategic goals and desire tocreate a neutral forum for all participants,” the exchange said ina prepared statement. “The exchange is very close to announcing itsown initiative to aggressively bring the system it envisions to themarketplace and would welcome Morgan Stanley and Goldman Sachs inthis new venture along with all other interested marketparticipants.”
Sprecher said his group is trying to find better ways to handlesettlements and other back office components of transactions,”which is why we approached Nymex.” He saidIntercontinentalExchange put Nymex on the spot by not giving it alot of time to consider a partnership. While regrettable, the shorttime-frame was necessary because it was expected once word ofIntercontinentalExchange got out it would be hard to control themedia buzz about the venture, Sprecher said. Another reason for atleast giving Nymex a heads-up was the seven partners represent alarge chunk of the open interest in oil and precious metals tradedon Nymex and other exchanges – about 30% in total, Sprecher said.
The fallout of the IntercontinentalExchange negotiations withNymex was that last week the exchange elected a new vice chair,Mitchell Steinhause. Two board members were ousted by Nymex memberswho were reported to be upset over the handling of theIntercontinentalExchange negotiations. Voted off the board wereAlbert Helmig and Gary Cohn, who is head of global commodities atIntercontinentalExchange backer Goldman Sachs.
“This new B2B e-commerce portal promises commercial participantsin the commodities markets access to a more efficient marketplacethan currently exists,” Cohn said. “The prospect of increasedmarket efficiency in the area of OTC commodity products is longoverdue.”
Currently, the vast bulk of trading in the wholesale OTC energyand metals markets is conducted via telephone. The capabilitiesprovided by IntercontinentalExchange’s platform will offerincreased market transparency, liquidity and efficiency whilepreserving the anonymity most market participants require, thepartners said.
“The size and the corresponding needs of participants in thesemarkets are far larger than most people recognize,” said Shear. “In1999, the notional value of OTC commodity contracts was more than$1.8 trillion and growing rapidly. We have seen that in markets ofsimilar size, where electronic systems have already beenimplemented, market quality has improved and operational costs havebeen significantly lowered for customers.”
Beyond establishing electronic markets, IntercontinentalExchangewill create the opportunity for the “paperless back office” withstraight-through processing of trade information for OTC products.IntercontinentalExchange also plans to develop facilities thatwould permit market participants to clear and settle OTC products.
“We believe that market participants will determine whatfunctionalities are most important to them in this newmarketplace,” said Francois-Xavier Saint-Macary, head ofcommodities trading at SG Investment Banking, a division of SocieteGenerale. “The ultimate vision for this industry-focused platformcomes from the interactive dimension of the net. One could imaginethe ability to view OTC and futures markets on the same screen, aswell as to route orders to existing futures exchanges or to theirelectronic platforms, credit intermediation features and links tomany other industry related sites.”
The technological backbone for IntercontinentalExchange is arobust and scalable trading system. The system provides marketparticipants with global trading support around the clock andthroughout the business week.
IntercontinentalExchange is to be headed by Sprecher, previouslypresident and CEO of Continental Power Exchange Inc., the companythat developed the trading system to be used byIntercontinentalExchange.
Joe Fisher, Houston
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