Doubters of the Emirate of Dubai’s ambition to take its place on the world stage would do well to look from the gateway of the Dubai International Financial Centre towards the Burj Dubai development. Featuring the world’s largest shopping mall and 30,000 homes, the project is topped off by the Burj Tower, the world’s tallest building. So adamant are the developers that no rival should outdo the Tower that they are yet to release its vital statistics.
Back in the DIFC, Dubai Mercantile Exchange (DME) chairman Ahmad Sharaf has a vision that is equally grand in scope, if a little more transparent in its execution. Should that vision play out, Mr Sharaf says, Dubai could become an energy trading giant with volumes far surpassing those of London and New York.
The DME is approaching the first anniversary of its launch, and it owes its existence to a combination of that global ambition and a wide gap in the market. “It was conceived on two different levels, one was obviously to serve the purpose of Dubai becoming a global city,” Mr Sharaf says. “The other purpose was to capture an opportunity out there… which was the pricing of sour crude in a transparent marketplace.”
Sour increasingly attractive
Sour crude contains higher levels of impurities than ‘sweet’ crude, which forms the basis of the much-traded West Texas Intermediate and Brent Crude contracts. It is more expensive to refine, but in a high oil price environment is an increasingly attractive commodity for traders.
Historically, sour crude contracts have been traded over-the-counter in Singapore, “But it was fast approaching the point where traders were becoming less comfortable with the process, and seeking other ways in which they could manage the risk,” says Mr Sharaf.
“As such, we embarked on this study and evaluation of setting up an exchange over here. Granted, you’ve got these two giants out there, you’ve got New York and you’ve got London with the West Texas and Brent contracts. Why would they need [another] contract, especially when all the crude in this region has destination restrictions?”
Regardless, the plan went ahead, with the New York Mercantile Exchange onboard as a technology partner. “One of the things Dubai has been successful at is ensuring that we establish lasting relationships with leading brands and Nymex is a winning brand in the space of energy trading. We established a relationship and started a joint venture,” Mr Sharaf says.
“What we came to realise very quickly in that conversation was… that while we had the best IT platform and we have the best clearing house… the one thing that was missing was the contract itself,” he explains.
That talent for relationship-building was needed again, but after six months of negotiations with the government of Oman, the DME secured its contract and a third major stakeholder, as the Omanis took a piece of the exchange through the Oman Investment Fund.
In the year of the DME’s conception, oil prices were still below $40 per barrel, and few would have imagined that they would rise to current, $100-plus levels, or predicted the parallel fall of the dollar to record lows against the euro. “We didn’t model this,” Mr Sharaf admits.
“We’re not soothsayers who can say what the future is going to be. One thing we do know is that the purpose of our exchange has always been and will continue to be a mechanism by which our customers can manage risk, whether the price is shooting up or shooting down,” he says. “We are here basically to provide the facilities and the secure infrastructure whereby they can manage that risk for themselves and their customers.”
Not quite ready to jump in
Local investors have been slow to adopt the risk management techniques and diversification that are expected in more mature markets, but Mr Sharaf believes that the will is there, even if the expertise is still lacking.“There’s truly a pent-up demand, just in Dubai, from banks,” he says.
“Many of them are Islamic banks, and they’re very interested in what’s going on here, but they’re not ready to jump in yet. Many of them trade in real estate, many of them trade in gold, many trade in indexes in the US as well. Very few of them have any exposure to energy commodities, and this is the platform on which they can diversify their portfolios.
“The challenge, obviously, is to get people educated to the point where they are comfortable with taking and managing risk in the futures space. Options and so forth are not something that’s akin to the way which we have traded.” To that end, the DME has set up another joint venture with the American University in Dubai to create the DME-AUD academy,” explains Mr Sharaf.
“It’s a slow process but it also is underpinned by those who know how to trade in this space, like the large banks who have come and housed themselves here,” Mr Sharaf adds. International names such as Lehman Brothers, Merrill Lynch and Standard Chartered are all present on the DME’s trading arcade alongside local players Daman Securities and Mashreq Capital. “[Foreign players] are the catalyst, they begin it and then, once they start showing success in it, because the products serve their customers globally, more of the regional players start coming into the fray as well.”
Traders required
For the time being, there are still a good number of vacant seats on the DME’s floor, and Mr Sharaf admits that the exchange is yet to reach the critical mass of traders required to become an unqualified success. “That hurdle’s going to take a bit of time, certainly it’s going to be defined by a volume, but once we reach that volume then the cards start falling into place.”
However, he denies that there is a limit to the patience of the DME’s investors. “We’re not rushing the marketplace,” he says. “We’re reacting to what the market needs. We’re reacting to what our customers need. This is an investment for the long term.”
Looking further forward, Mr Sharaf has an ambition of Burj Tower proportions. Pricing Oman’s 700,000 barrels per day of sour crude is only the tip of a 20 million barrel iceberg. Oman gave the exchange credibility, and, Mr Sharaf hopes, seeded something much bigger.
“Once all the other barrels come over here – if the Saudis start pricing and if Kuwait starts pricing, Qatar starts pricing, Abu Dhabi starts pricing against the DME – the numbers you get because of that initial move that the Omanis made, to price their barrels on the DME, you are going to start looking at a fantastic rise up in the volumes traded here in this exchange,” predicts Mr Sharaf.
“And it will, by far, overshadow what’s happening in New York and what’s happening in London.”
SWEET AND SOUR
The Dubai Mercantile Exchange lists the Oman Crude Oil Futures Contract, a physically-delivered sour crude future. The majority of oil coming out of the Middle East is ‘sour’, meaning that it has more than 1 per cent sulphide impurities and hence is harder to refine.
Only around 25 per cent of global oil reserves is ‘sweet’, and many of the world’s refineries have for a long time been geared to process the purer crude. Furthermore, much of the excess capacity that can be turned on by Opec to feed demand is in sour crude.
With demand for fuel increasing, the lack of refining capacity for sour crude is likely to put further upwards pressure on fuel prices. While this may seem counterintuitive at first glance, the lack of sour refining capacity and the inability to rapidly adapt existing refineries to process sour increases the demand for sweet crude. Prices, for the time being, show no signs of slipping.
NYMEX-CME MERGER
One of the DME’s main shareholders and its clearing partner, Nymex, is undergoing significant changes back in its home market. Nymex agreed in March to be acquired by the Chicago Mercantile Exchange and, subject to regulatory and shareholder approval, the deal should be completed later this year.
At the same time, US regulators and policymakers are debating whether the vertical trading and clearing silos employed at the major futures exchanges are anti-competitive, after the Department of Justice called for a separation. Further questions over whether the combined CME-Nymex, which already incorporates the Chicago Board of Trade, represents an unfair monopoly.
Both Nymex and the CME have defended their models, and despite opposition there remains a strong possibility that the merger will go ahead. In Dubai, Mr Sharaf welcomes the tie-up. “I see this as being a very positive thing for the DME,” he says. “Our product will be represented in a much larger community of traders, probably providing us with different tools by which we can expand our energy commodities space.
“The platform that the CME has, Globex, is one of the best in the world and the CME is an aggressive company. They have visited us on several occasions and they like what they see at the DME.”
The DME will continue to use Nymex’s clearing infrastructure as long as it is available, Mr Sharaf says, but it is interested in exploring the possibility of integrating with the CME’s Globex system. Ever looking for fresh partners, Mr Sharaf says: “At this time we’re not linked to it… but certainly with this conversation that Nymex is having with the CME, we will begin the conversation to see how we can link in to our benefit.”
