Horsnell: US policy will shift oil markets

Sam Fletcher
OGJ Senior Writer

Commodities market regulation in the US seems to be moving towards higher capital requirements and bureaucratization with relatively little impact on prices in the long run, said Paul Horsnell, managing director and head of commodities research at Barclays Capital in London. However, he warned, “Expect the center of gravity of world oil trading to move further away from US markets.”

After a long period of regulatory fog and uncertainty, more clarity may be about to emerge as to the revised regulatory backdrop for US commodities markets. “The main impact, in our view, is more likely to be on the structure, location, and composition of and the hedging costs in markets rather than…any lasting impact on the price levels those markets generate,” Horsnell said. “Whether or not there are short-term price effects within temporarily disorderly markets depends in large part on how the changes are presented and announced.” It is still “a bit early” to tell “which style of announcement will be applied to regulatory changes in commodities and, hence, whether there will be any short-term price distortions.”

However, he said, the nature of the regulatory and bureaucratic structures likely to be imposed on US commodities markets is becoming clearer. Recent testimony by Commodity Futures Trading Commission Chairman Gary Gensler in Washington seems “to involve higher margining requirements, a broadening of the regulatory ambit across over-the-counter markets, and a bureaucraticization and centralization of those markets.” Horsnell noted, “Gensler’s testimony did not link change in any way to the operation, participants, or performance of commodities markets. Instead, he linked change to the overhaul of the US financial system as a whole and in its entirety after what he described as its failing of the American people 1 year ago. The arguments based on specific commodities-based criteria have then, it seems, been abandoned in favor of arguments drawn from a generalized approach to greater regulation of financial markets in their entirety.”

A ‘philosophic mutation’
Horsnell said, “In other words, this seems to have mutated into regulation born of a general regulatory philosophy rather than being driven by the identification and attempted correction of specific market failures or distortions in specific commodities markets. The danger in that evolution is that the move to a more dogma-based motivation means that the regulatory process in the future may be less concerned by the nature of the distortions it throws up, given that it is the imposition of the regulation itself rather the correction of any specific distortion that has now become the main objective. That would imply regulation with limited market-based benchmarks to judge its own effectiveness or need, and that would not be a recipe for any flexible, pragmatic, or volatility-reducing regime.”

He said, “Other than the danger of a short-term disorderly market should implementation prove unexpectedly clumsy, we would not expect to see steady-state oil prices change as a result of the new regulation. In an industry that now needs more than $60/bbl to operate with any sustainability, prices cannot stay too much lower than current levels without stoking future price shocks.”

Meanwhile, Horsnell said, “We would expect some changes to the structure of the oil market. We would expect to see a degree of liquidity migrate away from US exchanges. We expect to see increasing costs for some hedging operations, potentially leaving commercial operations more exposed as they face a new and less favorable trade-off between risk reduction and its cost. Indeed, the scope for some types of risk management in US markets is likely to be truncated by cost and by transparency obligations, especially those with longer execution times in less liquid parts of the curve. Transparency is not necessarily a good objective to have in low volume areas of the market, if it means that even less volume can be traded before markets move severely against those engaged in the execution of risk management.”

Horsnell said, “The drive towards greater transparency of transactions does not always provide a benefit in those circumstances, and in those less liquid areas the danger is that liquidity will die away completely, leaving the market and commercial companies to carry a greater degree of time and basis risks.”

In other news, the latest statement of Saudi Arabia’s short and medium-term policies provides “a further signal” that $70-80/bbl for crude is considered a comfortable range for now, Horsnell said. Ali al-Naimi, Saudi Arabia Minister of Petroleum, indicated prices above $70/bbl are necessary to maintain investment and keep the oil market balanced over the longer term.

(Online Sept. 28, 2009; author’s e-mail:

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