Oil traders, funds snub new ICE Brent NX contract

Mon Nov 19, 2012 9:55am EST

* Hedge funds reluctant to be early movers

* Arbitrage players too small to kickstart liquidity

* Compulsory migration seen as more effective

By Claire Milhench and Emma Farge

LONDON/GENEVA, Nov 19 (Reuters) - Investors say they have no plans to switch to the new Brent NX contract which was unveiled over a year ago, leaving futures exchange ICE with tough choices to make in 2013 over how to terminate the existing benchmark.

The majority of fund managers care little about the technicalities of cargo delivery dates, the reason why ICE introduced the new contract, and some are barely aware it is on the board. The equivalent of just 0.1 percent of total Brent volumes has switched.

Many are reluctant to move to ICE's Brent New Expiry (NX) contract before it has built up enough open interest, creating a catch-22 situation in which users cling to the old contract.

Brent is used to price at least two-thirds of the world's oil, with an average daily open interest of $22 billion based on current prices at near $110 a barrel.

"The market is going to stay on the old contract until they are forced to (move)," said Olivier Jakob, an energy analyst at Petromatrix in Switzerland. "ICE will have to give a closing date for the old one in order for liquidity to shift."

"The problem with introducing any new futures contract is that of the chicken and the egg. As long as there is a viable alternative the market will stick with that," an energy broker agreed.

The new NX contract is being introduced to reflect a broader change in the underlying physical crude oil market by price assessment agency Platts, which aims to make a larger number of cargoes count in the process of setting Brent prices.

Platts is using a longer window to work out the price of dated Brent, assessing cargoes loading in a 10-25 day period, rather than 10-21 days.

IntercontinentalExchange Inc expected open positions in the old contract for December 2012 and beyond to migrate over the course of 2012 but progress has been slow. The December Brent NX contract expired on Nov. 5 with zero exchanges for physical.

Open interest, or the total amount of outstanding contracts, has gradually increased on NX monthly futures from an average of 37 contracts or 37,000 barrels in January to 1,406 contracts or 1,406,000 barrels in October. Still, this represents only 0.1 percent of the total volume on Brent.

Hedge fund managers said they were reluctant to make the first move, with some saying it was not even on their radar. Brent's nearest rival as a global benchmark is the Chicago Mercantile Exchange's U.S. light sweet crude futures contract, or WTI.

LIQUIDITY CONCERN

"Brent NX doesn't have much trading volume at the moment - there is not much open interest, and we don't want to be more than 15 percent of the open interest in any contract," said Yu-Dee Chang, portfolio manager at Ace Investment Stategies. "Liquidity is very much a concern."

A trader added that some small arbitrage players were arbing the difference between the two contracts but this was not enough to kickstart liquidity. "It's difficult to move the crowd from what they know," he said.

Chang said the migration of open interest had to happen in 2013 or it would not happen at all, and called for ICE to offer incentives to persuade people to shift: "I see the migration process being very slow unless ICE makes a big push to get people to move."

The exchange currently offers an "exchange for related market" option, allowing users to close a position in the old contract and open a position in Brent NX.

There is also no charge for switching between old and new Brent in the same month, but some market participants were unimpressed, saying it wasn't much of an incentive.

David Peniket, president of ICE Futures Europe, acknowledged ICE would need to take more steps to encourage the migration of liquidity but said the new contract needed to move through one or two expiries first.

"We want to monitor the initial expiries of the NX contract, and market participants will want to look at that to confirm the price judgements that they may have made in the past in terms of the relationship between the two," he told Reuters.

"But there are additional steps that the exchange will need to consider taking in order to encourage the migration."

Market participants expect the exchange to adopt compulsory migration in the end. "It's more effective to say, as of this date, the contract ceases to exist," said one. "But ICE seems reluctant to go down that path."

Peniket declined to comment on what additional steps would be considered to encourage people to switch but said it needed to happen in the least disruptive way possible.

One aspect that concerns the market is the possibility of split liquidity, where a sizeable chunk of money has rolled into Brent NX but the rest is still in the old contract. But Peniket did not think such a situation would last very long.

"A number of participants want to see a baseline level of liquidity," he said. "If you got to a stage where you started to see significant liquidity in the Brent NX contract and NX liquidity growing rapidly, the period where you have significant liquidity in both would be relatively limited."

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