Earlier this month, FIA hosted its annual commodities forum in Houston, Texas. In the hometown of the energy industry, we brought together people from across the commodities landscape for discussions about how much the energy industry has changed and what opportunities for the futures industry lie ahead.
We already know the demand for price discovery and risk management in the energy sector has been growing for years. And as I listened to our speakers, I heard the same refrain: demand will increase even more as energy markets grow increasingly complex and volatile.
US energy export leadership
Let me offer one example of the changes coming out of Houston. By now, most people know the US has become a leading exporter of energy. And while the headlines have conveyed how we export more than many of the countries typically associated with energy exports, I want to underscore the significance of that change.
Last year, the US exported 14 billion cubic feet (BCF) of liquified natural gas every day, more than any other country in the world. In 2018, the US exported 4 billion, about the same as Malaysia. And in 2013, we exported zero. Think about that. The US went from no export to becoming the world’s largest exporter in less than a decade.
The impact on futures markets
This tectonic shift in the global gas market has created demand for derivatives in at least two ways.
First, as gas moves from well heads in the Permian to liquification plants on the Gulf Coast and onto ships crisscrossing the oceans and then into ports and pipelines in Europe and Asia-Pacific, the companies producing, moving and using that gas face a lot of price risk along the way.
In some cases, they come directly to the futures markets and use contracts such as Henry Hub, TTF and JKM to hedge their price risk. In other cases, they go to the over-the-counter markets and buy protection from dealers, who then lay off their risk in the futures markets. Either way, we see a rising tide of interest across the gas derivatives markets as the physical market for LNG continues to grow and mature.
The second source of demand comes from financing. Another point I heard again and again from our speakers in Houston centered around the energy industry’s need for more infrastructure. Building a new pipeline or liquification plant can take years, and the banks that provide the financing need to have a certain level of confidence that the operators of these infrastructure projects will turn a profit when they come to fruition.
Enter derivatives. The banks are better able to offer that financing if the financing structure includes a hedge. Those hedges may not be visible to the outside world, but one way or another, the banks need to manage the risk embedded in those hedges, and the foundation for that risk management lies in the depth and liquidity of the listed futures markets.
Opportunities for innovation
All the talk in Houston about energy markets and risk management was music to my ears. And I know I’m not alone in coming away from the conference energized – pun fully intended! But we cannot rest on our laurels. We cannot just assume that the energy industry will continue to use the same products in the same way.
As the physical flows change, our industry needs to adapt. We need to design new contracts that suit the changing needs of our customers. We also need to ensure these contracts have enough depth and liquidity to support a meaningful level of hedging activity. And our partners in the exchange world – CME, ICE and Nodal – need the industry's support in bringing liquidity to these new contracts.
The crude oil market offers one example. Though different from the gas market, the evolution has been just as dramatic.
Ever since the late 1980s, people have traded Brent futures to manage their exposure to oil production in the North Sea. Today, times have changed. With production in the North Sea decreasing, the composition of the benchmark now includes Midland-grade oil from west Texas. As we noted in a previous FIA spotlight, exports of oil from Texas have influenced the pricing of global trading in crude oil. In fact, WTI Midland has been the most dominant grade of crude in the Brent basket since May 2023.
This shifting landscape led CME and ICE, the two most important exchanges in the oil futures markets, to create new contracts that track the price of this specific grade of crude oil. Although still very new, these contracts are catching on fast, as you can see in the chart below.
I commend CME and ICE for taking the initiative and rolling out these new contracts. And I commend all clearing firms and market makers supporting these new contracts. It’s a testament to our industry’s ability to adapt to changing times and develop ways to provide our customers with new tools for risk management.
I also appreciate these two exchanges competing head-to-head in this new market. They have competed fiercely for many years in the established crude oil markets, and I am not surprised they are putting so much time and effort into this new market. While no one knows which will prevail, the competition benefits our customers, and indeed, all of us who want to participate in the growth and evolution of the energy industry.
