May the best exchange win

The development of local energy exchanges is good for the region, but there’s not enough room for all of them. When a tanker arrives in Singapore laden with Middle East petroleum, and fills up with marine fuel for its own engines, the shipping company has no idea what it will pay for it—the bill arrives later.

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By  Nicholas Wilson Published  October 4, 2006

|~||~||~|When a tanker arrives in Singapore laden with Middle East petroleum, and fills up with marine fuel for its own engines, the shipping company has no idea what it will pay for it—the bill arrives later. This is clearly not a good way of doing things and stops tanker firms from programming their fuel budgets.

It is one of the problems caused by the Middle East being dependent on outside countries for many of the key components needed to get its products to consumers.
Likewise, the price of its oil sold on world markets is determined elsewhere and based on the price of sweet UK and US oil, and then calculated—adding an extra price risk—to determine the cost of its own, mainly sour oils.

The region’s maturing into an integrated, complete market, from seismic surveys to shipping and from spot and futures markets to project finance, will let its producers and traders manage their risks better. Unknowns are not good for business.

Take a refiner that needs to borrow money to increase production. The bank may say that as it does not know what oil or refined products prices will be in 12 months, it does not want to take the lending risk. If the company, however, can buy and sell its raw material and processed products 12 months ahead at a fixed price, on a commodities exchange, it can show that it is managing its risk.

This may seem obvious, but at a time of wildly fluctuating prices—usually the norm in the oil world—there are those who like to demonise the futures markets and blame investors for driving prices up. They point to the billions of dollars that investment funds have pumped into commodities exchanges since oil prices started to soar three years ago.

This, however, overlooks an important point: Oil prices started to rise first and then investors bought in. Consumer demand is the most important factor that drives energy prices. If the Chinese and Indians all started to cycling to work and Americans put windmills on their roofs, then investors would not want to know about hydrocarbon commodities exchanges.

And exchanges let everyone know what prices are being paid for commodities, both now and in the future, which lets companies plan their budgets and invest accordingly.

The Dubai exchanges are a good thing. And if they are joined by Qatar, with its planned liquefied natural gas contracts, the good thing will get even better, so long as they don’t all compete directly in selling the same contracts—the market is of a finite size and there is a threshold of liquidity that each exchange needs to have to be a success. If all three competed head on for a single product contract then it could result in failure for all of them.

That may happen if Dubai’s proposed LNG storage depot becomes a base for LNG futures trading, at the same time that Qatar’s planned Energy City commodities exchange starts selling competing contracts.

The nature of LNG means that curently its market has little liquidity for either spot or futures exchanges. There are relatively few LNG tankers and LNG terminals worldwide, nor are there are many ships on the seas whose cargoes are available to the highest bidder. Furthermore, LNG producers prefer long-term contracts to let them plan the vast amounts of start-up money they plough into their plants. A typical LNG contract consists of a tanker going backwards and forwards between two countries over a 20-year period.

Of course, the market will develop as more consumer and producing countries build LNG terminals and production plants, but it will be a long way behind the petroleum and refined oil products market in both volumes and liquidity for many years to come.

However, Dubai’s and Qatar’s attempts to give the region another vital component in the total commercial hydrocarbon chain are to be welcomed—may the best exchange win. ||**||

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