2nd UPDATE: ICE, CME Set To Battle Over Argus Crude Futures

Saudi Arabia's jump to a different U.S. oil price benchmark is setting up a battle between the two leading commodities exchanges, each hoping to corner a potentially lucrative new market.

IntercontinentalExchange Inc. (ICE) said Tuesday it will launch a crude oil futures contract based on the Argus Sour Crude Index, putting the exchange operator in direct competition with rival CME Group Inc. (CME), which announced similar plans last week.

The index, created in May by London-based energy market information service Argus Media, is based off of lower-quality oil produced in the Gulf of Mexico. Saudi Arabia had previously used an assessment of West Texas Intermediate, or WTI, high-quality crude delivered in Cushing, Okla., put out by Platts, a unit of McGraw-Hill Cos. (MHP).

The exchange operators are quickly rolling out the new derivatives to hold onto Saudi Arabia's U.S. customers, who use futures to lock in their purchase price in advance, reducing the risk from fluctuating prices. Futures tied to high-quality oil at Cushing would not provide the same protection for low-quality oil priced with the Argus index, and companies would likely have sought out custom, over-the-counter derivatives had the exchanges not acted. CME and ICE each earn 6% to 8% of their revenue from futures linked to WTI, according to Fox-Pitt Kelton.

Saudi Arabia currently supplies about 5% of U.S. oil demand. Venezuela, which exports slightly more on average to the U.S., is also considering a shift away from WTI, the country's oil minister said in an interview Tuesday.

The stakes are high from the start for ICE and CME. Traders are generally wary of holding positions in new contracts, as their low volume tends to leave them more vulnerable to wild price swings. The volume hurdle could be overcome if state oil company Saudi Aramco's customers begin using Argus-linked futures - but companies often flock to the exchange that can offer a critical mass of activity.

Both exchange operators are hoping to gain an early edge by attracting companies looking to bet on the difference in prices between the new contract and established benchmarks.

ICE, which controls the lion's share of activity in Brent, the London-based oil price benchmark, would need a strong Brent-Argus spread trade to emerge in order to dominate the new market. CME, which operates the leading Cushing-based futures contract, is angling for a thriving WTI-Argus market to develop.

Brent has grown into a leading benchmark outside North America, and is used to price oil exported from Africa to the U.S. But WTI remains the dominant benchmark in the U.S., where most of the early adopters of the Argus contract will be based.

"I would expect Nymex should win this one, if there's one to win," said Andy Lebow, senior vice president for energy at MF Global in New York.

Phil Flynn, an energy analyst with PFG Best in Chicago, predicted a tough fight for the market with CME holding the edge in WTI.

"At least initially, this is a contract that will increase volumes," Flynn said, adding that speculative commodity traders facing tougher position limits from Washington may be able to use an Argus contract as an alternative to WTI or Brent.

Executives at ICE said they anticipated an "incremental" increase in overall volume with the addition of an Argus contract, while a CME spokeswoman said that to whatever extent that CME's Argus contract is adopted by the oil industry, it would spur demand for Nymex's existing sour crude futures markets.

Observers noted that the perceived competition between the two dominant global energy exchange operators could amount to little if the contract fails to draw interest from commercial hedgers and speculators.

Craig Pirrong, director of the Global Energy Management Institute at the University of Houston, noted past attempt to introduce sour crude contracts in competition with WTI have fizzled, though crude grades around the world are becoming more dominated by sour varieties.

"Both Brent and WTI have become progressively less representative of crude grades in different locations over time, but nonetheless have continued to thrive, and nobody else really has been able to break that stranglehold," he said.

-By Jacob Bunge, Dow Jones Newswires; 312-750-4117; jacob.bunge@dowjones.com and Brian Baskin, Dow Jones Newswires; 212-416-2453; brian.baskin@dowjones.com

(Dan Molinski in Porlamar, Venezuela contributed to this article.)

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