NGI The Weekly Gas Market Report
The alliance of Calgary-based Natural Gas Exchange Inc. (NGX) and Atlanta-based IntercontinentalExchange (ICE) announced last week gives NGX entry into the United States and means that for the first time a suite of physical energy products will be offered in conjunction with the ability to clear physical transactions on the ICE platform.
TSX Group Inc. (TSX) is parent of the 12-year-old NGX, a physical energy exchange, clearing and settlement facility, as well as the Toronto Stock Exchange. The NGX alliance is just the latest move by fast-growing ICE. By aligning itself with ICE, NGX is attaching itself to one of the globalization/consolidation engines among commodities and other exchanges.
ICE is locked in a rivalry with the Chicago Mercantile Exchange to merge with the Chicago Board of Trade (CBOT) (see NGI, March 26; March 19; Oct. 23, 2006), having already completed the acquisitions of International Petroleum Exchange (see NGI, May 7, 2001) and the New York Board of Trade (see NGI, Jan. 15).
The agreement with ICE gives NGX, which has a robust Canadian physical trading and clearing business, entry into the United States. The cleared and bilateral markets for North American physical gas and Canadian electricity operated by NGX and ICE will be offered together on ICE’s electronic platform. In turn, NGX will serve as the clearinghouse for these products. This will complement the clearing ICE offers in its over-the-counter markets for financial contracts. NGX will also use the ICEBlock system to electronically accept for clearing off-exchange transactions in financial gas and other energy products.
“ICE will have their instruments and our instruments or products on their screen…We will deal with the physical clearing and the back-office activity,” explained NGX President Peter Krenkel. “We’re already doing a very high volume of Canadian business. We’ve got a limited bit of clearing activity in the U.S. but we look for that to increase.
“Specifically, here in the Canadian market combining our strong physical market with their strong paper market, I think we’ll provide a lot of convenience, efficiencies, value and trading opportunities for our clients. In the U.S. it gives us the opportunity to introduce our physical clearing services, which have proven themselves in Canada. It gives us the opportunity to introduce those to the U.S. markets and see whether the customers gravitate to that service.”
Krenkel said he was not familiar enough with the clearing services offered by the New York Mercantile Exchange to comment on how the ICE-NGX offering in the U.S. would be different. “We’ve cleared $300 billion worth of contracts; never missed a beat; everybody got their money; everybody got their gas,” Krenkel said. “We’re very happy with our track record. The model varies a little bit from what the traditional clearers use, but it’s one that the energy market participants have really embraced here in Canada.”
During the post-Enron era a number of energy trading players had hopes of offering up financial clearing services. One of them was EnergyClear Corp. (see NGI, Nov. 11, 2002). Krenkel told NGI that NGX was too busy building its Canadian business at the time to think about launching a U.S. offering.
“It took us a long time to develop this,” Krenkel said. “You have to understand how the markets work. You have to understand the gas flows. You have to have systems and procedures in place to deal with that. It’s fairly time-consuming, a bit labor-intensive, and it requires some specialized skills to get started. I know a lot of people have looked at the space and some have tried to do some things. None of them have ever really gotten critical mass that I’m aware of…”
TSX bought Calgary-based NGX in 2004 for C$38 million (see NGI, Feb. 2, 2004). NGX was formed in 1992 by Westcoast Energy and acquired by OHMEX in 2001.
“Obviously, the consolidation process is under way and I think it’s going to continue,” Krenkel said. “I think there are sort of too many regional and fragmented players in this in the globe. That applies to a lot of exchanges but certainly commodities. I think there’s going to be a shakeout. We feel we’ve got a very strong position in that sort of physical clearing space, and our belief is that those services will always be needed by the marketplace because the gas will always continue to flow, and credit problems will always exist, and volatility will always be there. We feel that the expertise we’ve built will continue to add value for all the market participants, although we do see that the chess game has started.”
But is NGX looking to expand its offering across commodities beyond energy, NGI asked Krenkel.
“Yeah, we’ll deal with that as those opportunities develop,” he said. “Clearly, the partnership is not specific to that. Suffice it to say, if we think we have a good working relationship as partners and our model is successful, I think it would be in the best interest of both our customers and shareholders to expand beyond this current product suite.”
ICE lauded NGX’s clearing and settlement model for creating liquidity in Canadian physical gas markets. NGX has enabled almost $300 billion of physical gas transactions since its inception in 1994. In 2006 more than 8.1 Tcf traded on NGX, said Krenkel. ICE introduced its financial clearing solution for energy products in 2002 while NGX brought physical clearing to energy markets more than a decade ago. Clearing removes counterparty credit risk from bilateral transactions, expanding market liquidity.
Financial terms of the alliance were not disclosed; however, ICE CEO Jeffrey C. Sprecher and Krenkel described it as a “perpetual agreement” during a conference call last week. “We both have a global vision,” Sprecher said. “It’s very much in our minds to expand this footprint.”
Sprecher said during a conference call Wednesday that he would have liked to have acquired NGX back in 2004 when it was bought by TSX; however, at the time ICE had not yet gone public and couldn’t afford the exchange. Krenkel told NGI he couldn’t speculate on how things might be different today had ICE been able to acquire NGX before TSX scooped it up.
“Things happened the way they happened for the business reasons at the time, and I’m not sure what it would be like today had there been a different turn of events,” Krenkel said.
“Since acquiring NGX in 2004, TSX has demonstrated a commitment to supporting NGX’s growth beyond Canada, as we expand our own international footprint in the rapidly expanding resources sector,” said TSX CEO Richard Nesbitt. “Each party pursued this alliance in the context of a long-term strategy and selected the other as its ideal partner. Over the past year, we have taken time to carefully plan and leverage the respective strengths of NGX and ICE in a way that will proactively support the evolution of the market.”
The alliance is not expected to be financially material for either party in 2007. The terms include certain usual and customary conditions, including applicable regulatory filings and approvals. The combined offering is expected to launch in the third quarter of 2007.
In other news, ICE last week announced the addition of two big bank advisors to its bid for CBOT. The new advisors joining Morgan Stanley are UBS Investment Bank and Societe Generale Corporate & Investment Banking. UBS, Societe Generale and Morgan Stanley are all ranked in the top 10 for Futures Commission Merchant (FCM) operations, based on U.S. customer segregated funds.
In a conference call Sprecher described the rapid rise of ICE, its success in integrating other merger partners, its technical abilities, including the ability to rapidly expand clearing operations, and the synergies of an ICE/CBOT combination. ICE’s all-stock offer of 1.42 ICE shares for each share of CBOT was valued at about $9 billion initially. Since then ICE’s stock has dropped from about $128/share to about $120/share Monday, lessening the value of the offer and leading Sprecher to say the company would consider adding “substantial” cash to the deal.
Also last week, ICE received a ruling from the U.S. Internal Revenue Service designating United Kingdom-based ICE Futures as a “qualified board or exchange,” which provides U.S. participants in ICE Futures markets with “60/40 tax treatment.” ICE Futures, regulated in the U.K., has a growing customer base in the U.S. and has approval to offer its screens in 46 jurisdictions around the globe. ICE Futures contracts now offer U.S. traders the same tax treatment as contracts traded on U.S. futures exchanges. With 60/40 tax treatment, 60% of gains or losses will be treated as long-term capital gains or losses, and 40% of gains or losses will be treated as short-term capital gains or losses. The ruling applies to contracts traded on ICE futures on and after April 1. Traders on the New York Board of Trade, ICE’s U.S.-regulated futures subsidiary, already receive 60/40 tax treatment.
In March, TSX and International Securities Exchange (ISE) announced the creation of DEX, a new derivatives exchange to be launched in March 2009. It will be owned 52% by TSX and 48% by ISE and will list and trade options, futures and options on futures on a range of Canadian securities.
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