A Fast New Financial Game Called Energy


Is the surge in oil futures trading exacerbating the market’s ups and downs?
The Commodity Futures Trading Commission and New York Mercantile Exchange put out a study saying hedge funds weren’t causing more volatility. That’s nonsense. Traders are attracted by volatility. In the 1990s we had pretty flat markets. We didn’t have a lot of trading volume. Now we’re seeing bigger price moves, $2 a day. We never saw that before.

What kicked off this trend?
The trigger was availability of talent. Enron went down in 2001. Utilities started exiting energy trading. You had this meltdown of natural gas and power trading. Some of these folks started their own hedge funds, and some were hired by hedge funds. You had this pool of talent.

Where did price increases come in?
We had higher energy prices beginning in 2004. People wanted to come into energy because it was headline news.

Banks and insurers also are in the game.
Banks are really the biggest player in this market. They have the capital base, the global positioning, the traders. They have the relationships, they’re in project financing.

So interest in the energy sector is moving away from owners and consumers?
This is a financialization of the energy markets, and it’s immature. We size it at $3 trillion, compared to, say, $26 trillion in interest rate swaps. Energy is the world’s largest business, at $4 trillion. It should trade at 6 to 20 times the physical market. The growth potential is enormous.

What’s the downside?
Risk, risk, risk. Energy is a risky business. You’ve got headline risk, weather risk, geopolitical risk–it just goes on.

What about volatility?
We saw a big hedge fund go down–Amaranth Advisors. But that’s only 1% of the market. There’s no risk to the financial marketâ…but [hedge fund investing] is too risky for small investors. This is big money that should know the risks and afford to lose it. Energy trading is a zero-sum game. When Amaranth lost $6 billion, somebody made $6 billion on the other side.

London’s Intercontinental Exchange (ICE ) came into this space about a year ago. What has that done?
ICE launched West Texas Intermediate crude futures last February. It was the biggest launch ever in trading contracts, [and] a lot of it was hedge-fund-driven.

Why so big?
They’re totally anonymous. That’s an attraction for traders. If you’re trading on the commodities floor, people know your positions. You know the size, the direction, the scale, the length of the trade. You don’t know any of that in cyberspace.

You predict that green trading is the next big thing.
The global carbon emissions market was about $25 billion for 2006, and it’s doubling every year. Once the U.S. enters a carbon-trading regime, the uplift will be incredible.

Where is the money coming from?
It’s coming from high-net-worth [individuals] and private equity. There’s unprecedented interest in clean energy. …When you put that together with the world’s largest business–energy–it’s going to be huge. It’s absolutely a new asset class.

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