Hedge funds, or private investment funds, represented about 9.05% of natural gas futures trading volume in the first eight months of 2004 and 20.4% of gas futures open interest, but their market participation actually appeared to “dampen” price volatility rather than cause it or increase it, the New York Mercantile Exchange Inc. (Nymex) said Tuesday in a new 2004 Market Participants Study.

The study was undertaken in response to public criticism last year from large end-users, including Huntsman Chemical, a major global manufacturer of diversified chemicals and a large natural gas buyer, about high gas futures prices, increasing price volatility and the growing market participation of noncommercial traders (including hedge funds) — which are those traders who cannot make or take physical delivery (see Daily GPI, Oct. 28, 2004).

However, Nymex’s findings were not enough to quiet some critics of the exchange. Tom Lord, president of Volatility Managers LLC, who will present his own analysis of the market influence of hedge funds next week in New Orleans at GasMart, NGI’s annual conference, said he believes Nymex has released just enough information to dispel recent criticism.

Lord said the exchange has an “economic incentive to assure that no one constrains the participation of large actors in the market. My expectation is Nymex is highly concerned that there could be a conclusion that hedge funds were negatively impacting the ability of commercials to hedge in their market space effectively.”

Nymex said assertions about hedge funds increasing price volatility have been “forwarded to the public arena without analysis or facts to support such claims… Confused or inaccurate assertions can do harm to the public dialogue on the issues of the day.”

The exchange said it found that in its benchmark light, sweet crude oil futures market, hedge fund activity constituted only 2.69% of trading volume. As a percentage of open interest, hedge funds constituted 13.4% in the crude oil futures market in the first eight months of 2004.

“In short, it appears that hedge funds have been unfairly maligned by certain quarters who are seeking simple answers to the problem of substantial price volatility in energy markets, simple answers that are not supported by the available evidence,” the exchange said in its study.

“The findings of the study are consistent with our belief that hedge funds do not negatively impact our markets,” Exchange President James E. Newsome said in a statement on Tuesday. “They generally hold positions significantly longer than other market participants, which supports the conclusion that hedge funds are a nondisruptive source of liquidity to the market.

“With regard to price volatility in the natural gas futures market, when hedge fund activity alone [is examined], as well as in connection to inventory changes, the data strongly suggests that changes in hedge fund participation result in decreases in price volatility,” Newsome added.

Nymex said that rather than the influence of hedge funds the shifts in gas supply and demand over the last few years can easily be cited as “clear contributors to the price levels and volatility to which participants in this market have been exposed. [The] dramatic increase in [gas] demand has been the driving force in eroding excess productive capacity.”

In support of that conclusion, the exchange included a chart from Arlington, VA-based consulting firm Energy and Environmental Analysis Inc. (EEA), showing excess gas productive capacity declining at the same time that natural gas prices have risen.

However, Nymex provided very little of its own data in its analysis, choosing instead to present participation percentages and their implications.

The participation percentages Nymex presented are really indisputable, said Tim Evans of Thomson Financial, but “the conclusion about the funds dampening market volatility just makes me go, ‘Huh?!’

“In point of fact, there have been periods where it is easy to demonstrate that fund activity has helped boost volatility, most notably during the short-covering spikes of November-December 2003 and September-October 2004,” Evans said. “Each time the funds were carrying significant short exposures and were caught by fundamental surprises.

“In terms of methodology, it looks to me like the study was based on a period of low volatility [January 2004-August 2004], when price swings were not really a problem,” he added. “I think if they had really wanted to answer the question, they should have studied the periods of extreme volatility just before and just after the study period.”

Lord said that since last October the market participation and influence of hedge funds has skyrocketed. “Do you realize that from Oct. 1, 2004 to the middle of February, the Commitments of Traders [report to the CFTC] for noncommercials almost exceeded 50% of all open interest? From October on was the first time ever that they exceeded 30% for more than a week.”

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