Oil trading down

September trades shrink by nearly half as market players face credit squeeze
By Yang Huiwen

OIL trading in Singapore, the world's No. 3 energy trading hub, shrank by almost half last month compared to September last year.
The problem? Severe strains in the global credit market have made it much harder for traders to borrow funds to punt on the future price of black gold, which is usually a booming market.

Trading in over-the-counter (OTC) oil derivatives fell by 44 per cent last month from a year earlier, according to price assessment agency Platts.

These derivatives, which include options, futures or swap agreements, are generally used to hedge against oil price fluctuations, and can also be used by speculators to punt on the market.

But while OTC trades can hedge against market volatility, market players are saddled with the credit risk of the party with whom they are trading. This is known as counterparty risk.

And in these uncertain times, with the recent failure of many financial institutions around the globe, market players are increasingly wary of such exposure.

With the recent freeze in global credit markets and much higher borrowing costs, market players, especially smaller firms, are finding it much harder to obtain financing from banks to do deals, say industry experts.

More than 70 firms trade in OTC derivatives here daily, said Platts Asia senior editorial director Dave Ernsberger. They range from global energy majors and investment banks to specialist energy merchants and smaller companies such as those in the shipping and bunker supply industry.

For some of the smaller firms, trading has ground to a halt as banks are reluctant to extend credit, he said.

Oil trading houses and investment banks have also been trimming their energy trading operations locally, contributing to the drop in volume.

In addition, there have been concerns that the transformation of investment banks Morgan Stanley and Goldman Sachs into commercial banks may drain more liquidity from the energy markets as they cut back their more speculative activities.

Oil industry consultant Ong Eng Tong expects a further slide in trading volumes, given the heightened market volatility, demand uncertainty and fluctuating market sentiment, which have left traders reluctant to take big positions.

'We'll see more pain before we get to the bottom,' said Mr Ernsberger, adding there could be another 15 per cent fall from current levels. 'It will take a year or two before trading goes back to the levels we saw last year.'

This increase in counterparty risk, exacerbated by the collapse of US investment bank Lehman Brothers, is spurring a move to clear OTC trades.

Traders who do not clear their OTC deals typically face a higher risk as they depend on their counterparties to perform.

Clearing houses such as Nymex Clearport and SGX AsiaClear which offer clearing for OTC derivatives to mitigate counterparty risk have reported a jump in demand for their clearing business.

Total trades cleared last month by SGX AsiaClear surged 145 per cent from August. Nymex Clearport, the largest clearing house in Singapore, expects business to double this month from September.

Counterparty risk is mitigated by transferring an OTC deal to the clearing house as the clearing house and its clearing members will act as central counterparty to the transaction.

'Nowadays, we are increasingly seeing larger companies trading with each other and then clearing their trades with SGX. Credit risks are unpredictable,' said Mr Benjamin Foo, SGX's head of clearing, commodities and AsiaClear.

'With the increased credit concerns, there is a growing acceptance of the need for clearing.' He added that Singapore is seen as a 'good location for Asian companies to maintain their clearing accounts and funds'.

'The process is not done as much here in Asia, compared to New York or London, but business has been growing tremendously,' said Nymex's senior director for Asia marketing, Mr George Ng.

'Now they don't mind paying a small fee to gain the stability and limit their exposure to counterparty risk.'


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