NEW YORK As global institutional investors diversify their holdings into commodities, the Dubai Mercantile Exchange is preparing for its May 1 debut and the launch of a new oil contract that will boost transparency in the growing sour crude market.
The DME, the first oil market in the region, is a joint venture between Tatweer, a wholly owned diversified investment subsidiary of Dubai Holding, which is owned by the government of Dubai, and the New York Mercantile Exchange. The new exchange is located in the Dubai International Finance Centre, which is offering tax advantages to attract financial institutions in a bid to rival New York, London and Hong Kong.
The new contract will be a futures contract for 1,000 barrels of Oman crude for physical delivery; clearing will be performed by Nymex Clearinghouse.
While the world is hungry for low-sulfur and low-wax light sweet crude oil such as the U.S. West Texas Intermediate or Britains North Sea Brent Blend output is on the wane.
The fast-growing economies of Asia are consuming higher sulfur and higher viscosity sour crude from the Middle East the region with most of the proven oil reserves and creating the need for a new benchmark in that category.
The DME Oman futures contract allows people to manage their risk; they did not have that ability before, said DME Chief Executive Officer Gary King in an interview. Its another tool in their tool box to hedge and manage pricing in volatile markets, he said, adding that sour crude oil futures will help institutions diversify portfolios with energy.
The DME will also fill the time-zone gap between the trading hubs of Europe and Asia, allowing market participants to react quickly to concerns and geopolitical issues that may affect oil prices, Mr. King added.
Sweet-sour crude spreads
Because of several factors, prices of WTI and Brent no longer serve as a reliable marker, or benchmark, for sour crude. As energy markets become more volatile because of geopolitical concerns, sweet crude benchmarks are no longer an effective way to manage risk in the sour crude arena, which mostly trades in the over-the-counter market, according to analysts.
It is a new full-pricing methodology, based on the DME settlement price, Mr. King said of the new contract. Its a paradigm shift in pricing for Middle East Oman crude oil.
This contract has all the makings of becoming a global benchmark for crude oil pricing. Its the first contract that has backing of a Middle East producer, and we know the oil world production is getting sour in nature.
Dubai or Fateh crude served as a benchmark for Mideast oil, but production has dropped below 100,000 barrels a day, not enough to provide reliable pricing. In contrast, the Oman crude output is around 750,000 barrels a day, with proven reserves of 6 billion barrels, which could last for 21 years at current production levels, according to industry data.
To emphasize the role of Oman crude as new benchmark, the DME will also offer two financially settled contracts, the WTI-Oman and Brent-Oman spreads, which should help address price distortion stemming from supply fluctuations.
People who may have to hedge positions in WTI or Brent can use the Oman spreads, which now allow people to trade those differentials, said Mr. King, who added that the DME will add a jet fuel contract that airlines and refiners are interested in.
If the DME was successful, Nymex management believes volume in all crude benchmarks, including the WTI and Brent, could increase, as spread trades drive higher volume across the board, said Richard Repetto, an analyst at Sandler ONeill & Partners LP, New York.
The DME has received a reasonably good response so far. Seventeen of 50 off-floor member spots have been filled, and 11 clearing members were approved. About 40 financial firms that are Nymex Clearing members will be able to trade on the DME.
One major supporter is the sultanate of Oman itself, which is negotiating to take a 30% dilutive stake in the exchange. The exchange is also making available 50 floor-member positions, which offer fee and margin advantages. Mr. King said more firms have applied to be market-makers than the 20 positions allocated by the exchange.
From the buy sides point of view, we can anticipate a lot more program trading, said Steve Forman, senior vice president at Prudential Bache Commodities LLC, New York. You are going to see treasury synergies because all of these firms have to put up margins on their contracts but always had to worry about the liquidity in the market and price slippage prior to the Oman contract, he said of the increased activity the new market and contract will create.
It will be a more robust market, which, for the buy side, means more efficiency in the price discovery and lower costs. One key factor for any market participant is the security of their equity involved in those trades, Mr. Forman added. All of this is backed by Nymex and its clearing house, which work with futures commission merchants like ourselves.
Another important factor is that the DME is an electronic market, powered by Nymex technology. The Dubai floor is not a pit but a trading arcade for full members.
When Nymex moved from a traditional marketplace to an electronic marketplace, their products got broader distribution, and this lowered the cost of these transactions, Mr. Forman noted.
To make its listings truly global in the worldwide universe of oil trading, the DME is seeking regulatory approval to provide access in a number of foreign markets. Approval has already come from Singapore and Japan.