MARKET DEVELOPMENT
Crude Palm Oil OTC Swap Use on the Increase as Prices Rise
Crude Palm Oil OTC Swap Use on the Increase as Prices Rise
31/03/2014 (The Star) - Trading and volume in over-the-counter crude palm oil (CPO) swap contracts is increasing, as supply pressures drive up prices and firms turn to the OTC market to hedge their long-dated exposures, say market participants.
On the supply side, dry weather in the first quarter of 2014 has put upward pressure on CPO prices. The average CPO price rose to $804 per tonne from $792 per tonne in the first two months of 2014, while CPO production and stock levels in Malaysia fell by 23% and 17% respectively over the same period, according to Moody's. Demand for CPO is also on the increase, with Indonesia and Malaysia both announcing new biodiesel mandates in the second half of 2013 which are expected to stimulate domestic consumption of CPO.
Malaysia's mandate is estimated to increase palm-based biodiesel consumption to around 500,000 tonnes per year while Indonesia's mandate will increase the nation's domestic CPO consumption by about 40–50% to 3–4 billion litres in 2014–2015, says rating agency Moody's.
With CPO prices on the rise, market participants are showing an interest in hedging longer-dated exposures in particular, say brokers. This is primarily being done bilaterally via Malaysian CPO calendar swaps which are US dollar denominated and then centrally cleared on CME's ClearPort platform. The OTC contracts are based on the monthly average price of Bursa Malaysia CPO futures contracts.
The launch of a centrally cleared OTC swap has meant that participants now have the option to clear on an exchange and volumes have been increasing, says Nelson Low, executive director, commodity products, Asia at CME in Singapore.
"In effect it is a clearing service as clients that previously were not able to mitigate counterparty risk and had to keep the swap bilateral now have the added option to clear the trade and pass the counterparty risk to the exchange," he says.
Since the launch of the OTC swap in June 2013, CME says it has cleared 18,000 contracts or around half a million tonnes of palm oil with open interest currently at 6,000 contracts.
Laren Tan, chief operating officer at brokerage firm Ginga Global Markets in Singapore, says there has been an increase in OTC CPO swap trading from clients due to the ability to go longer in duration on swaps rather than listed futures.
"The swap is US dollar denominated and it appeals to market participants who by policy may not be allowed to engage in non-USD products. Swaps are also traded differently – the futures are traded on the specific contract months while the swaps are customised where you can trade in single months, quarters, half or full calendar years and it can be quoted as far as 24 months going forward."
Tan says that liquidity on the listed palm oil derivative market tapers off after six months so it is hard to get large volumes on exchange for longer-dated trades.
"That is where the swap is more tailored to the requirements of the participants," he says. "Once the swap is submitted to the exchange for clearing, the whole process of mark-to-market and margin is exactly how you would trade on a futures contract."
James McKay, broker at Starsupply in Singapore, says there has been some activity from plantations looking at longer-dated swaps on the back end of the curve, but so far the main users of the swaps have been traders and energy houses.
"The OTC swap makes sense as it is US dollar denominated and not everyone wants to trade in Malaysian ringgit – that is probably the number one reason why we launched the product and why we are pushing it as a broking desk. A lot of people are not able to or would prefer not to trade Malaysian ringgit and this gives them an alternative," he says.
"The Bursa Malaysia options contracts have had problems with liquidity and interest and that is why we have decided to focus on the OTC market – we may look at palm options on an exchange-traded basis in the future but not at the moment," he adds.
On the supply side, dry weather in the first quarter of 2014 has put upward pressure on CPO prices. The average CPO price rose to $804 per tonne from $792 per tonne in the first two months of 2014, while CPO production and stock levels in Malaysia fell by 23% and 17% respectively over the same period, according to Moody's. Demand for CPO is also on the increase, with Indonesia and Malaysia both announcing new biodiesel mandates in the second half of 2013 which are expected to stimulate domestic consumption of CPO.
Malaysia's mandate is estimated to increase palm-based biodiesel consumption to around 500,000 tonnes per year while Indonesia's mandate will increase the nation's domestic CPO consumption by about 40–50% to 3–4 billion litres in 2014–2015, says rating agency Moody's.
With CPO prices on the rise, market participants are showing an interest in hedging longer-dated exposures in particular, say brokers. This is primarily being done bilaterally via Malaysian CPO calendar swaps which are US dollar denominated and then centrally cleared on CME's ClearPort platform. The OTC contracts are based on the monthly average price of Bursa Malaysia CPO futures contracts.
The launch of a centrally cleared OTC swap has meant that participants now have the option to clear on an exchange and volumes have been increasing, says Nelson Low, executive director, commodity products, Asia at CME in Singapore.
"In effect it is a clearing service as clients that previously were not able to mitigate counterparty risk and had to keep the swap bilateral now have the added option to clear the trade and pass the counterparty risk to the exchange," he says.
Since the launch of the OTC swap in June 2013, CME says it has cleared 18,000 contracts or around half a million tonnes of palm oil with open interest currently at 6,000 contracts.
Laren Tan, chief operating officer at brokerage firm Ginga Global Markets in Singapore, says there has been an increase in OTC CPO swap trading from clients due to the ability to go longer in duration on swaps rather than listed futures.
"The swap is US dollar denominated and it appeals to market participants who by policy may not be allowed to engage in non-USD products. Swaps are also traded differently – the futures are traded on the specific contract months while the swaps are customised where you can trade in single months, quarters, half or full calendar years and it can be quoted as far as 24 months going forward."
Tan says that liquidity on the listed palm oil derivative market tapers off after six months so it is hard to get large volumes on exchange for longer-dated trades.
"That is where the swap is more tailored to the requirements of the participants," he says. "Once the swap is submitted to the exchange for clearing, the whole process of mark-to-market and margin is exactly how you would trade on a futures contract."
James McKay, broker at Starsupply in Singapore, says there has been some activity from plantations looking at longer-dated swaps on the back end of the curve, but so far the main users of the swaps have been traders and energy houses.
"The OTC swap makes sense as it is US dollar denominated and not everyone wants to trade in Malaysian ringgit – that is probably the number one reason why we launched the product and why we are pushing it as a broking desk. A lot of people are not able to or would prefer not to trade Malaysian ringgit and this gives them an alternative," he says.
"The Bursa Malaysia options contracts have had problems with liquidity and interest and that is why we have decided to focus on the OTC market – we may look at palm options on an exchange-traded basis in the future but not at the moment," he adds.