August 13, 2009 3:00 am
Already laid low by the recession, the US natural gas market now faces its biggest structural upheaval since the collapse of Enron in 2001.
Regulatory concerns are adding new drama to a period volatile even by wild gas market standards.
Benchmark gas futures on the New York Mercantile Exchange traded at $3.56 per million British thermal units yesterday, near a 6½-year low and down almost 75 per cent from a peak of about $13.50 per MBtu in June 2008.
The combination of fresh legislation to move opaque derivatives into exchanges and clearing houses - together with trading curbs on speculators and Wall Street's banks - portend a dramatic change that some gas producers, consumers and speculators worry will dry up trading.
"The wrong regulations can be just as harmful as no regulation at all," warns John Arnold, founder of Centaurus Energy, a $5bn Houston-based hedge fund, and a former trader at Enron. Centaurus is one of the US's largest traders in natural gas.
Although the new rules are still under consideration both at Congress and at US regulator the Commodity Futures Trading Commission, some small changes that have been implemented show the potential for disruption.
Trading volume in the Henry Hub swap natural gas contract have already been affected by new speculative limits, plunging 25 per cent in July. Henry Hub is the US's most important natural gas pipelines hub and prices there set a benchmark.
Natural gas producers and consumers are particularly worried about changes still under consideration. They believe their costs will increase if US lawmakers follow through on plans to require privately negotiated derivatives, such as some natural gas swaps and options, to be cleared or traded on exchanges.
The prospect of an upheaval cannot come at a worse time for the natural gas producers.
Companies such as Devon Energy, the largest US independent gas and oil producer, rely on over-the-counter derivatives to hedge against volatile prices. The problem, explains Jeff Agosta, Devon's treasurer, is that Congress's desire to force those derivatives into clearing houses or even exchanges could add billions of dollars in costs to Devon.
The company's existing derivatives deals with the likes of Goldman Sachs do not require Devon to post collateral but contracts traded or cleared on an exchange would, draining the company's cash reserves.
"They have the potential to seriously impact [on] the normal functioning of the natural gas markets," he says.
Devon and other producers also rely on unique hedging contracts that are far more complex than the standardised products clearing houses deal with.
"By and large, the stuff that we do and the industry does isn't plain vanilla," Mr Agosta says.
These themes were echoed in hearings on energy trading held at the Commodity Futures Trading Commission in the past two weeks.
Chesapeake Energy, another US gas producer, said posting cash margin, or collateral, on an exchange would be a "significant liquidity drain on American companies".
The American Public Gas Association, a utility group, called OTC gas contracts "vital" and said forcing them on to exchanges would be a "burden".
The move by Congress to shift natural gas derivatives into exchanges and clearing houses is unrelated to any problem in the commodities market.
Lawmakers are weighing derivatives legislation after financial companies' exposure to credit default swaps caused systemic crisis in the world economy.
Barney Frank and Collin Peterson, respective heads of the powerful financial services and agriculture committee at the US House of Representatives, would include tighter rules for energy swaps in future legislation involving credit derivatives.
"We are trying to make it tougher and tougher for derivatives generally to escape regulation like they have over the last 10 years," a spokesman for Mr Frank said.
While producers and consumers worry about higher costs in derivatives deals, hedge funds, Wall Street banks and speculators worry about curbs on trading.
The CFTC is seeking to ration speculators' access to energy markets in hopes of averting future price bubbles, predicated on its belief that "excessive speculation" helped last year to drive natural gas and other commodity prices higher.
While some of the new measures are under consideration, the regulator has already extended its reach over a benchmark gas swap traded on the IntercontinentalExchange, subjecting it to the same caps on holdings as gas futures traded on the rival New York Mercantile Exchange.
Hedge funds say newly enacted limits on the number of financial gas contracts they can hold could force them to reduce positions or shift to less transparent private, bilateral markets.
The natural gas market is also an important source of commodity-linked income for several of Wall Street's banks and trading limits could affect their operations.
Banks such as Goldman Sachs, Morgan Stanley and JPMorgan (which last year bought Bear Stearns' large natural gas business) are very active in the market.
While the natural gas market is vast and many market participants worry about its future, difficulties in shipping and storing gas have kept it tied to US shores, lessening the -prospects that a regulatory crackdown would push the market overseas.
"It's a North American market," Mr Agosta says, summarising a view widely echoed in the industry: rather than move, trading will just dry up.
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