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Nymex Oil Trading

If we scroll back almost thirty years, then oil trading online as we know it today was virtually non existent, and we have to go back to the Yom Kippur war of 1973 to find the roots of today’s oil trading contracts, and oil trading exchange. Following the war, and again in the late 1970’s, crude oil prices rose dramatically to such an extent that various pricing controls and mechanisms were introduced by the US government to try to provide price stability and regulated supply. Perversely these controls had the opposite effect, keeping prices artificially high and above the market clearing price. Within eight days of taking office in 1981, the Reagan administration removed the remaining price controls, allowing the New York Mercantile Exchange to introduce the first gasoline futures contract in October 1981, with the crude oil futures contract being launched two years later in 1983. The NYMEX  trading market was borne, providing oil traders, oil brokers,  and the oil trading industry, the opportunity to hedge and speculate in the oil markets using derivative products, traded for the first time through a central oil trading exchange.

Now for those of you new to futures oil, or online trading oil ( and assuming you are not proposing to trade it physically and take delivery!), I would urge you at this point to pop over to another of my sites which explains futures trading in more detail and also how oil commodities  are traded in general.

The futures oil market plays a critical role in supporting major economies around the world, and contrary to popular opinion is not simply a market created for oil traders and speculators trading in oil. It’s primary function is to allow suppliers, producers, refiners and customers to hedge their future requirements for oil buying and selling in the market at a future contract price. In addition the oil futures market also plays a price discovery role for participants in other cash or OTC related oil markets.

Now as with many other markets ( currency options is one in particular) the oil futures market is changing very fast as interest grows from the retail investor and trader. Until very recently this market was virtually a closed shop, unless you were extremely wealthy or were prepared to trade in large contract sizes, with virtually all oil trading executed via the oil trading exchange. As we will see shortly, this is now changing with more and more opportunities for the smaller oil trader to enter this exciting and diverse market, but with lower risk and smaller lot size. These opportunities are increasingly being provided by oil brokers offering OTC mini contracts for online oil trading, which are often a tenth of standard contract size, so we will look at one in particular on the next page.

Most oil futures contracts are still traded through centralised exchanges and the principle ones in the US are the New York Mercantile Exchange ( NYMEX), and the Intercontinental Exchange ( ICE), where the West Texas Intermediate and Brent Crude are both traded. NYMEX, was, of course, acquired by the CME (Chicago Mercantile Exchange)  for $7.6bn in 2008).   Typically oil trades are executed either electronically or by open outcry in a pit, or a combination of the two, and as I hope you know by now, an oil futures contract is a legally binding instrument between the buyer and seller, so please make sure you understand both your legal obligations under the contract, and also all key dates relating to the oil contract which we will look at shortly. I hope it also goes without saying that these contracts are known as derivatives, as they are “derived” from a real product, which in this case is oil. All oil futures contracts have expiry or settlement periods, and in the oil trading market the bulk of trading has been based over 3 month contracts, although in recent years this has increased from months to several years.

Every oil trading exchange operates with a clearing house which ensures that trades are executed in accordance with the rules, and which guarantees that oil trading contracts are honoured and obligations met. In the UK, the London Clearing House ( LCH. Clearnet) operates for many different exchanges both in the UK and Europe. This is regulated by the FSA.  NYMEX and ICE in the US on the other hand operate their own clearing house and in this case are regulated by the CFTC ( Commodity Futures Trading Commission ). In addition to ensure that contracts are honoured and fulfilled, the clearing house is also responsible for setting margin levels, and also acts as an independent counterparty between the buyer and the seller, effectively breaking any direct bond ( rather like a solicitor holding assets from both sides in a sale).

Oil trading, does of course give you the opportunity to take physical delivery of the product, which many larger buyers do, since they have a physical requirement to buy oil, and this is available as an option on the NYMEX WTI contract. However, I will assume that you do not wish to take delivery of a large tanker of crude oil, and in the case of the ICE Brent contract this is purely a cash settled trade, as are most oil futures contracts. Trading positions can of course be closed in several ways, either by rolling contracts forward into the next period, or by taking an offsetting position in an equal number of opposite contacts, thus effectively making your net position zero. However, do please make sure you understand the nature of the oil futures contract you are trading when trading oil, since physical delivery can and does happen!!

When the CME Group (Chicago Mercantile Exchange) acquired the New York Mercantile Exchange (Nymex) for $7.6bn in 2008 it had already taken over CBOT for $11.6bn and so secured unique sets of commodity products with each merger: grain contracts from CBOT and energy and metals from Nymex and which now form the basis of the CME’s suite of commodity products.

Of all the products that came with the Nymex acquisition the most significant in terms of volume are the WTI crude oil contracts of which almost 900k are traded every day.  This is a dramatic increase from the 300k in 2005 and 176k in 2000.  Almost 500k Henry Hub natural gas contracts are traded and approximately 115k heating oil contracts.

This increasing demand for commodity derivatives has been driven by a number of factors, from the macroeconomic to the need for better returns as investors tend to turn to commodities when other markets fail to delivery.

Indeed energy commodity futures have become increasingly important since the WTI crude oil contract started trading on the Nymex in the early 1970s and is now the single most important energy futures contact with 137.4m contracted traded last year and almost 50m contracts on the ICE (Intercontinental Exchange).  This is despite Brent crude, the European benchmark oil contract, being seen by many analysts as a more accurate price measure as it is internationally traded whilst WTI is a landlocked US crude.  According to the Futures Industry Association Brent traded almost 75m lots on ICE last year with the total number of energy derivatives (futures plus options) reaching a colossal 656.9m contracts last year, up almost 13% on 2008.

The scale of futures trading, particularly when compared with the size of the underlying physical commodity production, has led to accusations that it is speculators, particularly in the crude oil market, which was responsible for the surge in oil prices to almost $150 a barrel in 2008.  However, speculators have historically played an important role in providing liquidity for both producers and consumers who wish to hedge (protect) themselves against price volatility and to guarantee supplies at a pre-agreed price.

In an attempt to address this issue the CFTC now publishes a more detailed version of its weekly  Commitment of Traders report in an attempt to bring a degree of transparency to the role played by both the Commercials and Non Commercials in this market.