Energy Risk; EU to examine commodity derivatives/physical market link

Tuesday, February 08, 2011

Energy Risk

 Following sustained calls from EU members to curb commodity derivative markets, the EU will research the link between derivative and physical markets.

The European Commission (EC) has announced that it will undertake new research to establish the nature of the links between physical and financial commodities markets as part of its calls for action on commodities and raw materials markets.

The communication on commodities and raw materials, released on Wednesday, contributes to a new initiative towards making Europe resource-efficient that was launched in January.

As part of the communication, which aims to adopt an integrated strategic approach linking commodities and raw materials policies with financial markets reform, the EC has identified the need to investigate further how derivatives and physical markets affect one another.

"Recent developments on commodity markets show that the prices of derivative and physical markets may be linked in multiple ways. Clearly, the price of commodity derivatives is influenced by the price of the underlying commodity. It is also clear that investors increasingly use commodity derivatives as part of their strategic investments," the EC states.

As such, one of the key elements of this new integrated strategic approach is "undertaking additional research on developments in financial and physical commodities markets with the aim of identifying how the linkages work".

There has been increasing clamour from some EU members to curb activities within derivatives markets, with speculation seen as the root cause of rocketing physical prices for products such as oil and wheat.

France in particular has been leading the charge. In September last year, three French ministers warned the EC that the country would overhaul its commodities oversight regulation in a bid to stop speculative commodities price movements caused by financial bets in the markets.

French President Nicolas Sarkozy had previously stated that forging an international agreement on tightening commodities derivatives regulation was one of his main objectives for France's presidency of the G20 group of leading global economies, which began in November last year.

However, despite EC Internal Market commissioner Michel Barnier saying that he was personally in favour of position limits for commodity trading recently, others within the EU have not been so quick to call for clampdowns. Sharon Bowles, chair for the European Parliament's Economic and Monetary Affairs Committee, told Energy Risk in November that "with regard to commodity derivatives, there's an awful lot of populism that gets talked up and we have to be careful we don't make things worse".

Market participants are glad that the EC is taking the time to examine the issues thoroughly.

"It's better this way than if the market is arbitrarily forced to change," says Alex Nimmo, renewable fuels broker at SCB Group. "[Derivatives influence on physical prices] is a controversial and difficult subject and although I think that the investigation may well turn out to be a waste of money, at least they're taking the time to establish what the connection is rather than take a sledgehammer to the markets."

Significantly, despite the stance from the French government and the perception that the EU is looking to clamp down on commodity markets, official releases have often taken a less hard-line approach.

For instance, in the public consultation on the Markets in Financial Instruments Directive (Mifid) released in December, the EC makes it clear it would rather adopt the 'heightened' position management approach, implementing limits when necessary instead of forcing a less-flexible regime onto the markets.