The gas industry is about to get another Henry Hub futures contract. The Chicago-based Merchants’ Exchange, the nation’s oldest exchange founded in St. Louis in 1836, announced that it will list cash-settled futures contracts in Henry Hub natural gas, light sweet crude, Brent crude, European gas oil, New York Harbor unleaded gasoline and New York Harbor No.2 heating oil. All of the contracts were approved by the Commodity Futures Trading Commission on Jan. 25. Electronic futures trading is expected to commence during the first quarter.

“Even before Enron’s failure, the energy trading community seemed to desire more than the available markets could offer to them,” said Exchange CEO Robert S. Hamada.

The New York Mercantile Exchange (Nymex) remains the largest and most active energy futures market in the nation, and its Henry Hub natural gas contract is the industry’s main benchmark. However, Hamada believes the market is in need of some new alternatives.

“We aim to meet needs in the energy market that are presently underserved,” he said. “We have conducted extensive research and identified those areas in which market participants are in need of additional functionality for hedging and futures execution. For example, by offering a fully electronic, transparent market that enables block trading, the Merchants’ Exchange will be offering functionality that, to date, has been only a dream for these market users.”

COO Jay Sorkin said new trading possibilities will come about as a result of a liberal block trading facility that allows people in the over-the-counter market to structure their deals off line as they do currently but them post them on the exchange for clearing. “They don’t have to go to another venue — a venue where the order may be broken into pieces, where both sides may not get filled in entirety, where there may be slippage on the price and so forth. They can actually create the deals off line, bring them to the exchange, and we’ll post them and send them on for clearing. And it’s a regulated futures contract, so to that extent it takes it off the credit books in some cases, especially if these are deals that are financed by one of the major banks.”

Patrick Catania, former executive vice president for product development and marketing at the Chicago Board of Trade, believes energy market participants will “welcome the transparency, level playing field and elimination of counterparty risk” provided by Merchants’

The exchange is an independent, demutualized and fully electronic contract market. It traded futures for 140 years in St. Louis, but when the Commodity Futures Trading Commission was born in 1975, the people that ran Merchants’ decided they didn’t want to get involved in government red tape and instead became strictly a forward and cash market.

The futures markets subsequently boomed and the Merchants’ Exchange fizzled out. When the City of St. Louis took Merchants’ building away, the members of the exchange cashed out and some members took the exchange private and brought it to Chicago. It was restarted in December 2000 with some agricultural contracts and now is moving into energy.

It is now an all-electronic platform that matches trades in real-time across a secure, proprietary network. The platform is a complete end-to-end solution for electronic trading services created by Exchange Cubed LLC, which has integrated elements provided by, among others, IBM, Savvis and TradinGear, Inc.

“Being all electronic, we don’t have a trading floor, we don’t have members, we don’t have open outcry, we don’t have pits that we have to build and we don’t have locals standing in them that make their money off of the orders that come in,” said Sorkin. “What’s different about us relative to the existing natural gas market is we think we’re cheaper — that’s what the industry tells us — but more importantly we are going to set up some trading possibilities that don’t exist currently. And this is being done at the behest of the customers in the field.”

Merchants’ contracts will be cash settled rather than settled through physical delivery. “We’re not getting into the physical delivery pipeline issues. Our contract specifications do include the physical delivery specs in there, but that’s just to give certainty to the people who use the contract that the specifications do line up with those at Nymex,” Sorkin said.

The specs for the contracts are as follows:

“We anticipate that at some point in the future, the structured trade futures will carry quite a bit of volume. We are not going to kid ourselves and think that we’re going to come busting out of the gate with big numbers,” said Sorkin. “We’re looking for the participants who know about us to begin investigating these types of structured trades and put a few orders in there… We think we’ll slowly but solidly build up a core volume.”

The exchange has outsourced market surveillance and oversight functions to the National Futures Association, while clearing is outsourced to the Board of Trade Clearing Corp. Merchants’ also plans to launch electronic trading of options on energy futures in the near future.

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