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Oil Swaps to Emerge From Shadows With Dodd-Frank: One Year Later

Oil Swaps to Emerge From Shadows With Dodd-Frank
Oil futures contracts trade on the New York Mercantile Exchange with listed prices, clearinghouses and CFTC regulation. On the other side, unregulated over-the-counter swaps have ballooned, trading off-exchange between buyers and sellers and sometimes outside clearinghouses. Photo: Jin Lee/Bloomberg

July 20 (Bloomberg) -- As the chief operations officer of Midstates Petroleum Company LLC, Ric Mayers keeps one of his two computer screens locked on the price of crude oil.

As he watches futures rise and fall, he decides when the Vernon, Ala.-based firm should load up or pull back on oil and gasoline supplies and when to hedge its bets with oil derivatives. The price swings can translate into 10-cent hikes at the gas pump one day followed by 15-cent declines the next.

“It’s really out of control,” Mayers, 27, said in an interview. “You don’t understand why it would be.”

The trade in oil derivatives has long been one of the world’s most opaque markets, with buyers and sellers of swaps, futures and forwards often not understanding who else was buying what, how much and at what prices.

The Dodd-Frank Act, the overhaul of financial regulation enacted a year ago, aims for the first time to bring transparency to oil derivatives as part of new rules for the $601 trillion global swaps market. The U.S. Commodity Futures Trading Commission and Securities and Exchange Commission are writing new regulations designed to limit risk and boost transparency after the largely unregulated trading in derivatives helped fuel the 2008 credit crisis.

The law gives the CFTC authority to regulate all types of oil-derivatives contracts. On July 7, the agency finalized a rule to require swap data reporting on 46 physical commodities, including crude oil. The data would lead to the first comprehensive survey of the size and complexity of the market for both cleared and non-cleared swaps, according to the agency.

‘Police Reports’

“The police have to have the authority to check out the whole marketplace and they should be filing police reports regularly so the rest of us know what’s going wrong,” John Parsons, a professor at the Massachusetts Institute of Technology, said in an interview.

During the last three decades, oil derivatives grew into a multitrillion-dollar business cleaved into separate and unequal markets with traders such as JPMorgan Chase & Co. and ConocoPhillips straddling both.

On one side, futures contracts tied to West Texas Intermediate and Brent crude have traded in New York and London with listed prices, clearinghouses to reduce risk and CFTC regulation. On the other side, unregulated over-the-counter swaps ballooned, trading off-exchange directly between buyers and sellers and sometimes outside clearinghouses.

Different Types

Companies trade different types of oil derivatives in different markets. Oil and gas companies execute 33 percent of their transactions with exchange-traded derivatives, while airlines conduct only one percent of their trades on exchanges, according to a June report by Greenwich Associates based on a survey of 309 corporations.

For example, Chevron and ConocoPhillips, the second- and third-biggest U.S. energy companies by market capitalization, trade futures, options and swaps, according to annual reports filed with the SEC. Chevron trades derivatives on the New York Mercantile Exchange, IntercontinentalExchange and directly with financial institutions and other oil and gas companies in private contracts, according to its annual report.

Meanwhile, the majority of Southwest Airlines Inc.’s more than 600 financial derivatives contracts to hedge fuel prices between 2011 and 2014 are traded with third-parties in the over-the-counter market, the airline said in its 2010 annual report.

Lloyd Avram, a Chevron spokesman, and Romelia Hinojosa, spokeswoman for ConocoPhillips, and Laurel Moffat, a spokeswoman for Southwest Airlines, declined requests for interviews about the use of derivatives.

$5.5 Billion

The five biggest U.S. bank derivatives dealers also trade a mix of commodity contracts. JPMorgan, Citigroup Inc., Bank of America Corp., Goldman Sachs Group Inc. and Morgan Stanley trade futures, forwards, exchange-traded and over-the-counter options and swaps to hedge or speculate in commodities markets, according to quarterly financial statements filed by the bank holding companies with the Federal Reserve.

U.S. bank holding companies recorded $5.5 billion in revenue in 2010 on trading of commodity derivatives, according to a report by the Office of the Comptroller of the Currency.

Now the CFTC is taking steps to bring transparency across the range of markets for derivatives. “Size is really hard to estimate,” Talib Dhanji, a partner at Ernst & Young, said in an interview. “Nobody has actually put it together.”

Data Declined

In the past, getting such data has been difficult at best. A task force on commodity markets organized by the International Organization of Securities Commissions in 2010 sought disaggregated data on oil swaps to “enable market participants to make better informed, more rational decisions.” Such data “would likely benefit the whole financial system,” the task force concluded in a report.

The Bank for International Settlements, the Basel-based organization that estimates the size of the over-the-counter derivatives market, declined the request to publish the oil data, according to the task force report.

The data that will now be collected by the CFTC may lead to reports similar to ones the agency has put out on the futures market since 1962, and weekly since 2000. While Dodd-Frank requires the agency to publish data on the swaps market at least every six months, CFTC Chairman Gary Gensler indicated a weekly timetable is possible.

“The market would very much benefit if we could strive towards similar periodic reporting of aggregate data,” Gensler said on July 7.

Position Limits

That data will also help the CFTC determine whether and how to limit speculation in oil and other commodities markets. A so-called position limits proposal, issued in January, has been among the most contentious Dodd-Frank rules at the CFTC and spurred more than 13,000 public comments from supporters such as Delta Air Lines Inc. and opponents such as Barclays Capital.

Limits on single months and all-months-combined positions for futures and swaps should be postponed, Brent Harris, managing director at Pacific Investment Management Co., said in a March letter to the CFTC.

“As a practical matter, the CFTC does not have any meaningful data on the size of the commodity swap market, and it would be premature to impose a position limit regime without fully understanding these markets,” Harris wrote.

At Midstates Petroleum, Mayers joined in a petroleum marketers’ letter-writing campaign to encourage the CFTC to adopt the limits.

“Massive positions held by speculators have contributed to price volatility that is simply unrelated to supply and demand fundamentals,” Mayers said in a March letter.

To contact the reporter on this story: Silla Brush in Washington at

To contact the editor responsible for this story: Lawrence Roberts at

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