Oil traders slip past U.S. rules via London loophole

LONDON (Reuters) - Oil traders continue to squeeze past tighter U.S. market rules via a loophole that allows them to bet for bigger stakes on certain fuel futures that are under British regulation, brokers and analysts said.

Traders in the oil options pit work at the New York Mercantile Exchange, September 9, 2008. REUTERS/Chip East

The opening in what has been called the London loophole, which U.S. authorities tried to close in June 2008, allows the kind of high-risk plays that concern the Group of 8 leaders who have shone the political spotlight on oil price volatility.

Traders buying oil contracts in London played a part in the spike in oil prices to nearly $150 a barrel last year, critics have said.

Trading volumes have since jumped on gas oil futures not monitored by the U.S. Commodity Futures Trading Commission (CFTC) on the InterContinental Exchange ICE.N (ICE) in London.

The 2008 voluntary agreement between the CFTC, ICE and the UK Financial Services Authority (FSA) implemented set position limits on oil contracts physically deliverable in the U.S. on the same basis as on the New York Mercantile Exchange (NYMEX).

Contracts on ICE such as the gas oil contract, the main European future linked to diesel and heating oil prices, and Brent crude futures were not covered by the agreement. That paved the way to the high volumes this year which traders said was a symptom of investors fleeing U.S. jurisdiction.

“Some of the European proxies are just as good to trade as on NYMEX,” Global Insight analyst Simon Wardell said. “You can substitute one for the other pretty easily. It’s not a big issue.”

Traded volumes on the gas oil futures contract on ICE surged by more than 20 percent in the first six months of 2009, from the first half of 2008.

The same contract does not trade on the NYMEX exchange, but traders said market participants were using it to bid up heating oil in the U.S. which has a similar end use.

NYMEX heating oil volumes dipped in the same period.

“There are no fundamental factors for this rise,” one trader based in Switzerland said. “People have woken up to the regulatory dangers and are migrating onto ICE.”

Open interest levels -- the number of outstanding positions on any given contract -- for the front-month gas oil contract on ICE hit a record high of 113,400 lots on June 12 of this year. Traders said some parties had taken out positions totaling as much as 50,000 lots.

Positions on the NYMEX heating oil contract are limited to 7,000 lots.

Particularly high open interest levels last month pointed to higher participation of market players who do not take delivery of contracts at the end of the month.

“Non-fundamental players were trying to muscle the market in their direction,” one trader said. “The huge positions were unprecedented.”

Part of the rise in volumes was due to the buying of gas oil to store and sell at a higher price later, a profitable ploy this year, but most traders said this was not the full story.


In the year since the London loophole closure agreement for U.S. crude futures, volumes on U.S. crude traded on ICE in Europe have fallen sharply.

While the number of contracts of Brent crude traded on the ICE in the first 5 months of 2009 was relatively stable compared with the same period last year, volumes on U.S. crude were down by 1 million contracts a month on average.

Asked about the lack of firm position limits on some ICE contracts, the Financial Services Authority (FSA) told Reuters: “In order to satisfy the requirement to operate markets which are fair and orderly at all times, all UK exchanges have incorporated broader position management powers into their rules.”

Under this arrangement, the FSA grants ICE the authority to request or force traders’ to reduce or close positions if they deem it necessary.

But traders said they had seen little evidence of ICE ever acting on large positions. ICE declined to say how many times in the past year it had asked or forced an investor to reduce the size of a position, citing client confidentiality.

“Anyone who is in the market will migrate to the exchange with the more friendly regulation,” Wardell at Global Insight said.

The CFTC has said it may consider recommending foreign exchanges adopt position limits and reporting requirements that match U.S. rules if they are to keep access to customers in the United States.

In the United States the CFTC is seeking comments from market participants on implementing position limits across commodity futures contracts, and possibly doing away with exemptions for any investor who does not plan to take final delivery.

Mike Wittner, head of oil research at French bank Societe Generale said moves by the CFTC were making some investors wary.

“It would be premature to say they’re actually selling (on the back of CFTC announcement), but it does dampen sentiment,” Wittner said.

“If the FSA would announce something similar, people would sit up and take notice.”

For a Reuters columnist John Kemp’s “Spotlight falls on London commodity regulation” double click on </KEMP>