What drives the success of some index commodities like Brent Crude Oil or Milling Wheat to become global benchmarks? Can the energy revolution in the U.S. change the way the world views benchmarks such as WTI Crude Oil or Natural Gas?
To find out the answers, we recently had the special opportunity to interview Gary Morsches, managing director of global energy at the CME Group, Nicholas Kennedy, head of business development of commodity derivatives at NYSE Liffe and Mike Davis, director of market development for ICE Futures Europe.
Nick and Mike discussed some key points in common across some commodities that have enabled the transition from a local to a global benchmark. According to them, the first role of a commodity futures contract is to be a hedging tool of the physical commodity, and it should be representative of where the traders are located. Initially, all futures contracts serve a local region where the commodity is produced, then consumed nearby. If there is infrastructure in place to deliver throughout many regions, promoting global usage, then the commodity has a chance of becoming a global benchmark as long as it is being consumed across the world. The focus then needs to remain on the key users since the moment they stop consuming the commodity, its representation of a global benchmark will collapse. This reverts back to the first role of the futures contract where it is used to hedge the physical exposure. If the physical market disappears, then the relationship underpinning the commodity futures market is gone.
In our discussion with Gary, he mentions two key factors changing the landscape of energy today. Simply, he agrees with Nick and Mike that logistics are imperative to the global growth of the locally produced crude oil in North America. However, he dives into some detail about pipeline reversals, new pipelines and railroad transportation as important infrastructure developments. The second major game-changer he mentions is the technology that is increasing the production from the US and Canada. It is effectively backing out all of the crude imports into the US, creating self-sufficiency and changing the crude flows worldwide. Not only is the technology changing the price of crude but it is impacting the prices of refined products, final products and natural gas. So far, the price setting is spreading throughout Central America, South America and Europe, setting the stage for a global shift that could result in an index impact via constituents and weightings according to the rules in the methodologies.