December 16, 2013 / 12:06 PM / 4 years ago

CME unveils new oil futures contract to tackle Canadian discount woes

5 Min Read

CALGARY, Alberta, Dec 16 (Reuters) - CME Group Inc will launch its first light sweet oil futures contract for Canada on Monday in the latest attempt to help producers limit the price misery caused by overcrowded pipelines.

The Edmonton Sweet futures contract will give producers, refiners and speculators in the Canadian oil patch the opportunity to lock in light oil prices up to four years in advance and hedge their exposure to wild price swings.

Canadian crude tends to trade at a hefty discount to the West Texas Intermediate benchmark because a lack of space on export pipelines to the United States means crude shipments get bottlenecked in Alberta.

Sweet crude in Edmonton for January delivery last traded around $13.30 per barrel below WTI, having been close to parity in May, while front-month Western Canada Select, the region's de facto benchmark heavy grade, plunged below $40 per barrel under WTI in November.

That volatility poses a problem for producers trying to manage capital budgets, an issue the new Edmonton Sweet contract is intended to help tackle.

It will be settled against Calgary-based broker Net Energy Inc's index, with prices based on light sweet crude delivered in Edmonton from a number of different pipelines.

"The ability to lock in a differential between WTI and Edmonton Sweet is definitely an advantage. It provides more clarity on the pricing regime in Canada," said Scott Brundrit, marketing and transportation manager at Athabasca Oil Corp .

Athabasca Oil, a 6,500 to 7,000 barrel per day light oil producer with projects in northeastern Alberta, does not currently hedge its production, but Brundrit said that was likely to change as output and capital programmes increase.

"It (Edmonton Sweet) would certainly be a tool we could use in future as liquidity improves," he said.

Talisman Energy Inc, which produces about 2,000 bpd of light oil as part of its 371,000 boepd output, uses a range of oil futures contracts to hedge and said it may consider using the new Edmonton Sweet contract in future.

"We plan to monitor the launch and operation of the futures contract and see if we need to use it down the road," said Talisman spokesman Brent Anderson.

Liquidity Matters

The question of liquidity will be crucial to the success of the new futures contract, industry players said. This will be the third Canadian crude oil futures contract launched by the CME Group, the largest U.S. futures exchange operator, and results so far have been mixed.

Trade in a Western Canada Select futures contract, known as WCC, is steadily gaining in popularity. Around 500 contracts trade every day, according to Dan Brusstar, senior director of energy research and product development for CME, more than double the volume seen this time last year.

But a synthetic crude futures contract launched two years ago failed to capture the interest of the market. While the contract is still available on the CME, it has no liquidity.

Brusstar said the group was confident the new sweet contract would be much more actively traded thanks to booming production.

"I think this sweet contract will be more active than the Syncrude one. Based on all the smaller producers in the sweet, I think it's got a more diverse production base so that will probably make it more active and more liquid," he said.

The specifications of Edmonton Sweet crude are similar to a number of Canadian conventional light oil streams, as well as Bakken crude from North Dakota, meaning those producers will also be able to use the new contract to hedge, Brusstar said.

Overall, conventional crude oil production in Western Canada is expected to reach 1.44 million barrels per day by 2030, up from 1.25 million barrels per day in 2012, according to the Canadian Association of Petroleum Producers. That was the highest level since 2004, thanks to the use of horizontal drilling to unlock mature basins.

Bakken production is expected to hit the million-bpd mark for the first time this month, and rise by another 25,000 bpd in January.

Bank sources in Calgary said that, while it was often very hard for new oil future contracts to catch on, there seemed to be real demand for a tool to hedge light sweet production.

"These things usually take a while to develop. Initially it will be something of closest interest to the producers in Western Canada and the North Dakota Bakken," said Patricia Mohr, vice president of economics and commodity market specialist at Scotiabank.

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