Clearing will solve energy market woes, says University of Houston

Over-the-counter clearing of energy derivatives contracts could provide the market with the required transparency to help rebuild the energy trading industry, according to research by Global Energy Management Institute (GEMI) at the University of Houston’s Bauer College of Business.

Following Enron’s demise in the energy trading sector, “manipulation schemes, legal questions, credit issues and an unpredictable price index” have continued to plague energy trading, GEMI said in a statement.

In the past, trades were based on the reputation of buyers and sellers, but because of the market’s volatility, there is now a great deal of uncertainty from both sides, GEMI added. But clearing could reduce collateral requirements for buyers and sellers by up to 50%, because it provides a mechanism against default, GEMI director of energy markets Craig Pirrong said. “The results would include transparent trades and restored trust,” he added.

But Pirrong said that while market clearing may be the solution to today’s energy trading woes, there are still open questions about the optimal clearing structure. The New York Mercantile Exchange, Houston-based EnergyClear, Atlanta-based IntercontinentalExchange, Chicago-based Merchants Exchange and New York-based Virtual Markets Assurance Corporation are among the institutions that currently offer over-the-counter clearing services, each providing slightly different clearing platforms.

But some market participants have questioned the applicability of clearing for the OTC energy markets. Paul Newman, managing director of Intercapital Commodity Swaps in London, said much of the counterparty credit protection offered by clearing can be provided at around a tenth of the price through the mechanism of regular bilateral margining.