LONDON: The oil industry is bracing itself for new regulation, welcoming moves to prevent market abuse, but tighter position limits could stifle liquidity and bring greater price volatility.
The new rules, being drawn up by the US Commodity Futures Trading Commission, are expected to be imposed in stages over the next couple of years in an attempt to increase oversight and curb speculation in the $600 trillion over-the-counter (OTC) derivatives market.
Even if implemented in full, the rules are hardly draconian.
The proposals would limit positions in the spot month of derivatives markets such as crude oil futures to 25 percent of deliverable supply, and limit open interest held by any party to less than 10 percent of forward futures months in most cases.
Most traders see some level of position limits as necessary and argue there should be rules to stop one party, or group of parties, manipulating markets in their own interest.
But there is a real worry that interfering with free markets could inhibit liquidity and lead to sharper price spikes — up or down.
"We welcome regulation that may prevent some of the larger swings in prices that we have seen. But regulators need to be clear about where the problem comes from," said Ian Taylor, head of Vitol, the world’s biggest independent energy trading house.
"Markets work"
"We are … concerned that some of the possible regulatory changes being considered will severely hamper the industry’s ability to trade and deliver energy," Taylor said in a speech entitled "Energy Markets do Work" last month.
Oil analysts express similar concerns, saying artificial curbs on markets can be counter-productive if badly imposed.
"By restricting the positions of those that add liquidity you can create volatility. They (the CFTC) should tread very carefully with these regulations," said Leo Drollas, chief economist at the Centre for Global Energy Studies.
The heads of other trading houses are generally wary over how any limits are imposed, but many argue some level of regulation is necessary if it prevents "dominant positions" in commodity markets.
"We don’t think that position limits in financial markets is necessarily a bad thing," said Marco Dunand, chief executive of Mercuria Energy, one of the world’s top five energy traders.
"The market shouldn’t allow any player to accumulate a position that is in percentage terms of such a influence that it actually distorts the liquidity of a particular contract," Dunand told Reuters in an interview.
"A dominant position is not good for the market."
A senior manager at an oil broking firm agreed: "I would be worried if any participant had between 10 and 15 percent of open interest on a given market. I think it’s good to police this."
But how the regulations are imposed could make a significant difference to their impact on commodity and energy markets.
Many traders worry new regulations could raise the cost of doing business and thereby limit the volume of trading.
Harmony
Regulators on both sides of the Atlantic are keen to encourage OTC markets to clear their deals, using a third party to check on the creditworthiness of all parties to ensure they can all fulfil their financial obligations.
But clearing costs can be high.
Whatever the level of position limits imposed, oil traders say it is essential that the new rules are clear and transparent, with broadly similar rules in all markets to help limit what traders call "regulatory arbitrage."
"It would be good to have a certain harmony in regulation so that regulatory arbitrage does not take place," said Dunand.
"If one market is more regulated than another there could be migration towards the less regulated market," he said. "My biggest concern would be if regulation is not clear. That would limit your ability to participate."
A senior strategist at another large trading house agreed: "You give trader a rule, he will make money. You don’t give a rule and he will get angry," he said. –Additional reporting by Dmitry Zhdannikov
