If you're waiting for the Iranian oil bourse (IOB)
– the proposed euro-based petroleum futures exchange in Tehran – to overthrow
the global dollar-based economy, don't hold your breath. Establishing a futures-trading
mechanism to compete with the powerhouses of the New York Mercantile Exchange
(NYMEX) and the Intercontinental
Exchange (ICE) for the oil trade is as
probable as U.S. energy independence in our lifetime.
Futures exchanges were created to allow buyers and sellers of particular goods
to transfer forward price risks. That remains their function today. Think of
a futures contract as a proxy, similar in function to a coin – it is something
you hold until you can exchange it for the "real good" at a future
Futures contracts – standardized agreements between buyers and sellers – are
not stocks or bonds. Stocks and bonds are issued by corporations, governments,
or other entities to secure financing. Investors usually buy them from broker/dealers
blessed by the Securities and Exchange Commission, an agent of the federal government.
Why does this matter? Stock exchanges do not create and guarantee the products
they trade. Futures exchanges do.
Creating futures contracts is a tall order. Minimal conditions for contract
success include a liquid underlying market, minimal state intervention, enforceable
property rights, and a framework for dispute settlement. Balancing the advantages
between long and short is critical to design.
So imagine the IOB creating a futures contract settled by actual physical delivery
(like the NYMEX contract) and answer this: would a Persian Gulf contract favor
the long futures holder (such as China, the second largest oil importer in the
world) or the short seller and deliverer (in this case, the Iranian government)?
And what if there were a repeat – voluntary or involuntary – of the 1973 oil
In such a case, not only would China's long oil contracts become worthless,
but reduced Iranian supply would likely double the cost of obtaining the physical
oil on the open market.
In addition, China would have the headache of figuring out what to do with
a $40,000 per day tanker in the straits of Hormuz. Triple whammy.
Can't happen? Oil futures did not exist until 1983, so they have not experienced
a jarring event like a major embargo. But this is exactly what did happen in
the grain markets when Jimmy Carter declared a grain embargo
on the Soviets in 1980. Grain companies that had hedged large grain sales
to the USSR were left holding the bag on long positions in futures, physicals,
and ocean freight.
The IOB could, of course, design its contracts to be cash settled like the
Brent Crude oil contract
traded on the ICE. But who would dictate and manage the settlement price except
a committee of Iranian government officials? Who would arbitrate disputes over
The clearing house for any exchange guarantees its financial integrity. The
clearing house safeguards against default among its various clearing members
by collecting (and remitting) deposits in accordance with contract settlement
prices and members' net long and short positions. It also has the power to demand
additional funds, order liquidation, transfer positions, and suspend trading.
The clearing house, however, is funded by its members, which are mutually at
risk in case of default. To date, the IOB is mum about capital requirements
of clearing membership. Its clearing operation, described
by one of its creators, former IPE director Chris Cook, as "a new partnership-based
synthesis of bilateral trading between users combined with a collective guarantee,"
sounds as if the traders are not responsible for coming up with the dough in
case of default – some other "risk/treasury partner" is.
How many oil traders are going to feel confident trading an untested oil contract
through an untried clearing mechanism?
When Turkey established its futures exchange (TURKDEX)
last year, it had the wisdom to choose an SEC and UK capital-markets-approved
intermediary, Takasbank, to operate its clearing function, and it required all
members make adequate capital contributions to its guaranty fund.
Most writers enthusing about the potential of the IOB are underestimating the
enormous challenge of creating a functioning futures exchange with international
participation. And even if the embargo scenario is of low probability, it is
unclear how the IOB would prevent the appearance of market manipulation when
the state controls the production and distribution of the product.
The ultimate question is, who's going to take the other side of the trade –
some speculator in Peoria?
(Of course, that's not possible, since the U.S. prohibits trade and investment
Bottom line: if a euro-based oil futures market succeeds, it will happen at
the established exchanges that already have deep liquidity and a large customer
base. The oil trade in futures and physicals may indeed one day switch to the
euro because of growing fault lines in the dollar, but not because of the creation
of an Iranian oil bourse.