By Claire Milhench and Zaida Espana
LONDON Feb 22 Crude oil market players
expect a slow but steady migration of open interest from the ICE
Brent contract to the exchange's new NX contract in 2012
against the backdrop of a changing physical market.
The new NX contract is being introduced as part of a broader
change in the underlying physical crude oil market by price
assessment agency Platts, designed to make a larger number of
cargoes count in the process of setting Brent prices.
Derivatives exchange ICE introduced the New Expiry
(NX) futures and options last year with December 2012 as the
front month and an expiry calendar based on 25 days
instead of 21, in line with the Platts move.
ICE's existing Brent crude futures contract will continue to
operate as the only Brent contract until November 2012. From
December, both the old and the new contracts will trade in
parallel for an undefined period.
"As the contracts will co-exist, I see little reason to be
the first mover," a senior trader said. "Eventually it will be
replacing the existing contract, so the move over will happen
naturally. No need for additional incentives."
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, to ensure more cargoes are captured.
The pricing agency made the switch to capture additional
cargoes as supplies from the four North Sea crudes used to set
the dated benchmark -- Brent , Forties , Oseberg and Ekofisk -- also known as BFOE, is falling
steadily due to natural declines.
"This is becoming more of a long-term traded market," said
David Ernsberger, global editorial director, oil at Platts.
"People are thinking further ahead when they are looking at
securing their crude cargoes."
However, although the new ICE NX contract is better aligned
to the underlying physical pricing structure, to date there is
very little open interest in it. The Dec. 2012 contract had some
33 lots of open interest on Feb. 21, compared with 113,026 lots
in the equivalent ICE Brent contract.
This is partly because much of the liquidity in the Brent
contract tends to be in the front three months, although there
is volume throughout the curve. Trade sources said that the
absence of a June NX contract makes the popular play of
June-December spreads difficult as well.
"As there is no front-month spread, the liquidity on the NX
contract is low," a senior trader said.
A spokeswoman for ICE Futures Europe said the market was in
the early stages of transition after the launch in December, and
the exchange expected a gradual migration of open interest as
the front month contract nears.
"The futures market is waiting to exhale," said Ernsberger.
"It won't be until the ICE NX December 2012 contract becomes a
relatively prompt futures contract, that these kinds of
discussions will gather pace."
Most market participants expect the new contract to gain
traction in coming months.
"I think some 70 percent of the open interest is generally
in the contracts which expire within 12 months, so as we
approach December I expect more and more take-up," said Jeremy
Charlesworth, chief investment officer at Moonraker Fund
Management, a commodities fund of funds manager.
A slow migration also allows traders to reprogram their
systems to reflect the switch. "Until the back office is done,
the front office won't be allowed to play," the trader said.
But pioneering market players will exploit the differences
in price between both Brent contracts, creating an initial pool
of liquidity that will eventually migrate to the new contract,
trade sources said.
Market participants say it is important for the Brent
futures to reflect the changes to the Platts physical price
assessment to avoid divergences between the two that could lead
to price spikes in the futures.
Jorge Montepeque, global director of markets and pricing at
Platts, said that the expiry and trading of futures relative to
the cash market was becoming increasingly disconnected.
As a result, the existing futures market is relying on too
few cargoes for its settlement process.
The market is looking at a number of options to encourage
the open interest to migrate to the new contract. ICE Futures
Europe is offering participants the facility to switch between
the existing Brent and Brent NX contracts free of charge.
Montepeque highlighted other options such as volume limits,
or imposing financial penalties on those lingering in the old
contract as expiration date approaches. "That disincentive could
increase the longer they stay in," he said.