Six months on, the main selling point for the Dubai Mercantile Exchange's Oman crude futures contract could also be its biggest obstacle, if traders continue to use the facility as a way to buy or sell physical oil.
As the first Middle East contract to offer an option to deliver physical crude at expiry, the DME has attracted a host of oil majors, trading companies, producers and refiners willing to take the chance of supplying or accepting 500,000-barrel cargoes.
But hedge funds, speculators and local players who can help build liquidity and ensure its success as a futures exchange, could be deterred by the unusually large volumes carried to delivery -- 6 million barrels in the January contract.
This equates to about 193,000 barrels per day (bpd), or a quarter of the total production of Oman crude and condensate, and many traders expect that volume to continue.
By contrast, physical delivery of U.S. crude as traded on NYMEX, the world's most liquid oil contract, exceeded 4 million barrels only once in January 1995.
"I am sure physical delivery will be constant this year. There is no reason for it to change," said a trader with an investment bank.
The DME has managed to survive the curse of many past Middle East crude contracts, which have failed within months, but has yet to establish itself as a viable vehicle for hedging and speculation.
Where other major benchmark contracts such as NYMEX's West Texas Intermediate (WTI) crude or ICE Brent see open interest decrease as the contract expiry approaches, the Oman contract displays the opposite behaviour.
Open interest for the front-month February Oman contract stood at 3,873 on December 14, the day for which the latest data is available.
This compares with 3,658 lots on November 15, leaving the door open for a record physical delivery of February Oman crude.
Those contracts represent about half of the exchange's total open interest, showing the focus on the first month's contract and its physical delivery, which has become increasingly popular with traders.
"Lots of players see the DME as a decent and flexible way to access physical Oman," a Singapore-based trader said.
Adding to the momentum, term contracts for 2008 Oman crude have given a growing role to the DME.
Traders say the largest seller of Oman crude, Shell, is selling most, if not all, of its Oman equity through the exchange to trading firms that have taken the bet they will be able to fill short positions with refiners on the exchange.
"Shell did not sign term contracts with Chinese traders this year and even Japanese companies are said not to have signed with them. So they are selling a lot through the DME," another Singapore-based trader said.
Shell holds a 34 per cent equity stake in Petroleum Development Oman (PDO), which produces about 90 per cent of all Oman crude output.
A growing range of trading companies has taken delivery of Oman through the DME over the past two months, from Russian trader Gunvor, to U.S. company Sempra Energy and Japanese trading houses, traders say.
A record 5,997 lots, or 5.997 million barrels, of Oman crude are going for delivery in January, when 2008 term Oman contracts kick off, almost a third higher than the previous record of 4,283 lots achieved for the December contract.
The exchange now faces a conundrum -- it needs to build liquidity in order to get speculators and hedgers trading it more regularly; to do so it needs to minimise the risk of physical delivery, which means increasing liquidity.
The DME says it expects more companies to enter the market as they grow confident that the delivery mechanism works, but an increase in industry participants anxious to buy or sell real oil may not get the desired result.
"If liquidity starts to build, the ratio of delivery will fall. But for now it may be scary for funds to participate if they don't want to take or make delivery," said Tony Nunan, manager at Mitsubishi Corp's risk management unit.
Total trading volumes have been growing, but slowly, with a total of 42,658 contracts sold on the DME during November, up from 39,885 for October.
That meant a higher ratio of physical deliveries than in October, with 14 per cent of all contracts traded in November being physically delivered, against 10.74 per cent in October.
The surge in open interest last month could have been the result of new term contracts for 2008 Oman, prompting a rise in the volume of physical crude that traders wanted to acquire through the exchange.
If physical deliveries stabilise at around 6 million barrels, while trading volumes continue to grow as more companies join in, the exchange may still become more attractive to hedge funds and speculators.
Daily trades so far this month average 2,103 lots, slightly above the November average of 2,027 lots, despite an expected slowdown in volumes with the upcoming holiday season. (Reuters)
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