NEW YORK May 6 The CME Group intends to launch at least two new U.S. crude oil futures contracts before the end of this year, as the rapid growth in U.S. oil production and infrastructure boosts liquidity in Gulf Coast spot markets.
The contracts, likely to include one light sweet crude near the Houston hub and a reboot of its Louisiana sour contract, would complement rather than compete with its existing West Texas Intermediate (WTI) futures that is based on delivery into Cushing, Oklahoma, Dan Brusstar, Senior Director of Energy Research & Product Development at CME, told Reuters in an interview late last week.
CME, whose flagship New York Mercantile Exchange (NYMEX) crude contract has lost ground to IntercontinentalExchange's European Brent futures , first mooted the idea of new Gulf Coast-based contracts in late 2011.
Brusstar's comments are the first to suggest the CME is nearly ready to move ahead, although not necessarily with a sole focus on the new Enterprise Crude Houston Oil (ECHO) storage terminal as it first proposed.
If the new contracts overcome the industry inertia that often dogs new futures products, they could herald the biggest change in oil derivatives trading in decades.
"The entire Gulf is developing into a much more robust trading area," he said. He cited the Houston hub, the area around the Louisiana Offshore Oil Port (LOOP) as well as St. James, Louisiana, an area just up the Mississippi from New Orleans that is an increasingly popular rail and pipeline hub.
"Being optimistic, we're looking to launch something by the end of the year. The market is going to be there."
The contracts would likely be based on physical delivery, as is WTI, he said. Although the CME has not finalized any contract specification, the heavy sour crude contract could be based on West Canada Select (WCS) and may involve revamping its existing Gulf Mars crude contract, which has been mostly moribund for four years.
A surge in domestic and Canadian oil production has increasingly converged on the Gulf Coast, a region that until a few years ago was largely dependent on imported crude. Now, shale oil from the Eagle Ford and Permian Basin of Texas, coupled with new pipelines bringing Canadian shale oil south, is allowing refiners to push out imports and take more local feed.
For the CME, the key to success will be the expansion in oil pipeline, terminals, storage tanks and other infrastructure that would allow users of a physically-backed futures contract the flexibility to make or take delivery at expiration.
A host of new developments have created a far more varied, liquid trading environment, including the recent reversal of the 225,000 barrels per day Longhorn pipeline to ship West Texas crude to Houston and the 400,000 bpd southern leg of the Keystone XL pipeline, due to start pumping crude from Cushing to Port Arthur, Texas, before year's end.
Last week, Enterprise Products Partners said it would expand also its network near Houston, including plans to more than treble capacity at its ECHO terminal to more than 6 million barrels, plus about 55 miles (90 km) of pipeline to connect with refineries.
The CME's initial plan a year and a half ago was focused on a contract delivered at the ECHO terminal, but Brusstar said that the exchange was now casting a wider net.
"What's happening now is the physical trading is starting to develop some more liquidity around Houston, but it really hasn't fully gelled around any one specific terminal yet," he said.
"ECHO is in a great position with their expansion, and some other terminals in that vicinity that are expanding, we're continuing to talk to people," he said.
LLS INTO ST.JAMES?
Another option could be a Light Louisiana Sweet (LLS) contract based into St. James, which is also the destination for a growing number of trains delivering light sweet crude from North Dakota's Bakken shale and other new oil patches.
Demand for derivatives to hedge price risk for the expanding cocktail of domestic crudes that are now being pumped and refined on the Gulf Coast is helping boost trade in some of the CME's existing products, most of which are based on financial settlement against published price assessments.
Trading volume in Louisiana Light Sweet (LLS) futures, one of many CME contracts that converted from a swap to a futures last year, has quadrupled to an average of more than 2,000 contracts a day in March versus last year. Open interest has doubled to around 70,000, CME data show.
Despite the rise in trading activity, the CME faces daunting odds in garnering sufficient support for a new contract. A host of previous efforts to launch physically-delivered oil contracts around the world -- including the CME's Mars futures launched in 2008 with delivery into Loop -- have failed over the years.
Some traders have also questioned whether a new contract merely risks siphoning liquidity away from NYMEX WTI, a once global benchmark that has yielded market share to ICE Brent over the past three years as the growing build-up of domestic production left the landlocked Cushing contract behind.
Brusstar sees the opposite as more companies follow the lead of refiners like Valero, which has boasted about completely weaning itself away from imported light sweet crude for its Gulf Coast refineries to run domestic grades instead.
"Most of the U.S. grades are going to be pricing as a differential to WTI anyway, so we see it as a net positive to both WTI and Cushing," he said. "As more imported grades are pushed out and displaced -- most of those being Brent-related -- there will be some switch over to WTI pricing." (Reporting by Jonathan Leff; Editing by Marguerita Choy)