Shift to cleared trade could unblock oil markets

By Jane Merriman - Analysis

LONDON (Reuters) - Exchange-style clearing offers a way forward for the multi-billion dollar over-the-counter market in oil derivatives that has seized up because of the credit crisis.

Volumes of over-the-counter (OTC) trade slumped in September after the crisis in the banking sector made participants nervous about counterparty credit risk.

"The physical oil market is still operating normally but the paper market is experiencing problems," said Ian Taylor, Chief Executive of independent oil trading firm Vitol.

"OTC trades have gone down dramatically during this economic crisis and as traders exit from commodities, volatility increases," he said at this week's Oil & Money conference in London.

NYMEX Clearport has provided a solution for some participants, with a large number of OTC trades in oil being cleared on its system.

The OTC market is where derivatives are traded bilaterally between brokers, investment banks, oil companies, trading firms and other counterparties.

These instruments can be used for hedging price risk as well as for speculative trading strategies.

But when the credit crisis caused turmoil in the banking sector in September, volumes fell as participants became nervous about counterparty risk.

Huge moves in the oil price, which has more than halved in just three months, is also causing strain for OTC participants.

"Today nobody trusts anybody in terms of counterparty risk," said a senior executive at one trading firm.

Some have turned to NYMEX Clearport, set up in 2002, which offers exchanged-based clearing of OTC trades.

This can reduce counterparty risk because trading positions are backed up by margin payments paid into a central clearing house.

CLEARING DEMAND JUMPS

NYMEX Clearport's volumes in OTC oil contracts jumped up 176 percent year-to-date at the end of October.

"The oil markets are in need of contracts that offer clearing for OTC deals that were previously done bilaterally," said Joe Raia, managing director, energy and metals products at CME Group (CME.O), which owns NYMEX Clearport.