Slow take up hinders new ICE gasoil contract

Fri May 11, 2012 12:13pm EDT

* Old gasoil contract attracting lion's share of liquidity

* May deliveries for new contract slump vs. April

* Timing of fund manager liquidity switch seen as key

By Claire Milhench

LONDON, May 11 (Reuters) - The slow take up of Europe's new cleaner ICE gasoil contract will be overcome if the exchange follows the U.S. approach and amends its existing contract rather than running two versions in parallel until 2015, market participants said.

Lack of liquidity in the new contract is posing a problem for fund managers and traders looking to switch, and has led to suggestions ICE should follow the Chicago Mercantile Exchange's example and simply change the specification of its old contract.

Olivier Jakob, an analyst at Petromatrix, said it was hard for people to leave the more liquid contract. "It's difficult to run parallel contracts - the money will go where you have the liquidity. Everyone waits for everyone else to move."

Open interest in ICE's new low sulphur gasoil contract is still only around 1 percent of that in the old contract, although physical traders say the new contract is better aligned with market requirements.

The new contract needs to establish enough liquidity to attract fund manager flows, but this poses a catch-22 as the commodity indices and the passive money tracking them are still in the old contract.

Jodie Gunzberg, commodities director at S&P Indices, said there were strict eligibility criteria for including new contracts in the S&P GSCI, a popular commodities index. "Liquidity is a major factor in the decision," she said. "One of the key benefits of the S&P GSCI is that it is trackable."

Traders have criticised ICE's decision to run the old contract alongside the new until January 2015, even though this was only implemented after extensive consultation with market participants.

"It's very stupid to have two contracts at the same time, it's bad management," said one senior gasoil trader. "Nobody is going to move their flow, even though the physical players are getting toasted by the volatility."

One of the biggest bugbears for some physical traders is a persistent backwardation at the front end of the old ICE gasoil curve, which does not reflect market fundamentals as demand remains so weak.

Other traders suggested the old contract was a victim of its own success. "It will take time because the old ICE contract is so well established," one said.

U.S. SWITCH

ICE said the period of parallel trading gives market participants adequate preparation time to migrate their positions to the new contract. But a similar approach in the United States has just been abandoned.

The CME completed its own switch to a low sulphur contract by amending its existing heating oil contract. Initially it had launched a separate diesel contract. "However, the market didn't embrace trading in that contract," a CME spokesman said.

Gary Morsches, managing director, global energy at CME Group, said the decision was taken to concentrate the liquidity in one contract. "(It's) what our customers prefer. It allows for easier rolling of positions and minimises operational and programming challenges. The back-office workload is also lower."

Now some market participants are asking whether ICE should do the same, rather than go through a protracted transition.

A successful first delivery in February failed to trigger a rapid uptake. In April, some 30,000 tonnes was delivered against the new contract and 71,800 tonnes against the old.

But in May deliveries for the new contract slumped to 8,100 tonnes, while the old contract's leapt to 403,400 tonnes.

"Everyone thought that once the whole expiry/delivery had happened then maybe it would pick up in terms of volume but it is still not really happening," said one trade source.

On a more positive note, some fund managers are monitoring the new contract, looking for opportunities to enter. "We are always trying to trade the contract that makes the most sense," said Philipp Polzl, co-founder of Qbasis Fund Management.

"If they are trying to make this the main contract then it is just a question of time," he said.