Energy Swap

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An energy swap is a financial instrument whereby one participant agrees to a fixed-price contract for say crude oil, natural gas, gasoline, electricity, coal and other energies on a settlement date, while the other counterparty takes on the spot price, or the floating price of the commodity. The contracts are often used to hedge the fluctuating price of energies.

For example, say a large energy user agrees to pay a set price for crude oil. The other participant, usually a large financial institution, then agrees to pay the current market, or spot price.[1]Energy swaps are used by energy producers, commercial users of energy, banks and other financial institutions to hedge energy price risk.[2]

Energy Swaps and Regulation

Energy swaps are a huge part of the global OTC energy business. The Intercontinental Exchange's (ICE) standardized OTC energy contract for clearing of OTC energy swaps was introduced in 2002, and generated about $400 million, or 30 percent of ICE's revenues in 2011.[3][4]

The exchange announced plans in July 2012 to convert all of its OTC energy contracts into futures contracts, and would do so on October 15, 2012 in tandem with CFTC rules, that set the definition and guidelines for financial and commodity swaps. The reasoning by the exchange for the move, is to shift its customers away from OTC regulatory rules and over to more established futures rules. The CFTC swaps rules include provisions that require swaps participants to post additional margin and collateral for such trades. [5] The CFTC rule on commodity swaps, which was due to become effective on October 12, 2012, was postponed by the regulator until December 31, 2012 to allow more time for firms to comply.

CME Group, which operates Clearport, an OTC trading platform that converts bi-lateral OTC swaps into cleared futures, generated about $300 million of revenue for the exchange in 20111, or about 9 percent of its revenue.[6] CME is also working on a system to process energy swaps into futures, in compliance with the CFTC regulations.


References

  1. Trying to recast energy swaps as futures to skirt stricter CFTC rules. ICE.
  2. ICE Melts to Futures. Wall Street Journal.
  3. ICE OTC. ICE.
  4. CFTC grants last-minute relief on CME commodity swaps. Reuters.
  5. ICE plans transition of cleared energy swaps to futures. Reuters.
  6. CFTC grants last-minute relief on CME commodity swaps. Reuters.