REFILE-UPDATE 2-CME to change heating oil futures specs to reflect sulfur change

* May 2013 HO contract will have 15 ppm sulfur content

* Contract spec change avoids messy transition

* CFTC approval is expected

By Jeffrey Kerr

NEW YORK, March 23 (Reuters) - The CME Group will adjust specifications for its heating oil futures contract to meet new diesel requirements in New York in a bid to avoid a replay of the chaotic gasoline contract transition that roiled the market, in 2006, the exchange said on Friday.

The CME said contracts for its heating oil futures in months after April 2013 will carry the specifications in line with New York state's cleaner ultra-low sulfur diesel specifications, allowing traders to hedge forward purchases on the current contract, which trades on the group's New York Mercantile Exchange.

The adjustment means market players will not have to switch into the CME's new ultra-low sulfur diesel contract, which has attracted low trading volumes.

The exchange hopes this will avoid the trading problems that occurred when NYMEX moved from its NY unleaded gasoline (HU) to the NY reformulated blendstock for onboard blending (RB or RBOB) futures contracts.

That difficult transition drew the ire of many market players as the specifications were very different. For longer-dated hedges, traders had to expose more of their books to over-the-counter markets, where transparency was lower.

"This is a really good development for the exchange and should make it a lot easier for the CME to hold onto its volume advantage in this vital contract," said independent energy market analyst Chris Henwood of Henwoodedge.com in New Jersey.

The CME said that starting with the May 2013 futures contract, the current heating oil futures specification will switch to Colonial Pipeline grade 61 ULSD with a maximum sulfur content of 15 parts per million. Colonial is the largest pipeline delivering fuel from Gulf Coast refineries to the East Coast.

The ultra-low sulfur diesel contract will still be available to trade, however, if the market decides to shift over.

"We have no plans to delist the LH (ULSD) futures contract, but we will just let the two contracts trade side-by-side," said Dan Brusstar, CME Research Director.

SWITCH TO ULSD

ULSD, which is greener than regular diesel, is already in use across much of the United States, primarily as on-road and off-road diesel.

New York State will switch all heating oil over to a 15 ppm sulfur standard as of July 1, 2012, a move which has forced companies in the region to shore up supplies of the refined product in advance and sent differentials of the premium diesel product up to eight-month highs in recent weeks.

Houston-based Buckeye Partners -- one of the top pipeline suppliers to the region -- mandated that at all of its lines and terminals in New York will have heating oil with no more than 15 ppm sulfur by April 15, 2012, to meet the new requirement.

Other East Coast states will switch later. New Jersey plans to change over by 2016 and other New England states have made plans to follow in the years after that.

Pennsylvania has postponed indefinitely plans to switch in 2012 due to the shutdown of refineries in the Philadelphia area key to supplying the state's fuel.

It was the lack of urgency from Pennsylvania in making the switch to ULSD that ultimately swayed the CME to stick with the heating oil futures contract, said Brusstar.

The CME had planned to stick with its decision to move to the new contract, but once the state delayed its implementation, it decreased the urgency of the change and allowed the exchange extra time to consult with the industry. The industry favored sticking with the current contract and changing the specifications to reflect the new standards.

The U.S. Commodities Futures Trading Commission has not approved the change in contract specifications yet, but the CME is confident that the change will be approved.

While the decision will likely appease trader concerns about changes in the heating oil contract, which began trading in 1978 and was the first successful launch of an energy futures contract anywhere in the world, analysts said that the market would have eventually adjusted to the new ULSD contract as it has to RBOB.

"There could be some confusion among people wanting to hedge or play the spread right around the period the specifications change, the same as we have a couple of times a year in the gasoline market," said Tim Evans, energy analyst for Citi Futures Perspective.

"In my view it was never going to be a major disturbance since we've been through it with RBOB and unleaded gasoline and it functioned fine."