Yesterday, CME Group (NYMEX) announced that it is increasing margin requirements for numerous energy products including crude oil, refined products and NGLs, effective today.  To provide a few examples of the most liquid (actively traded) products:

Initial and maintenance margins (for those classified as hedgers) for Tier 1 crude oil futures (CL) are both increasing from $5,000 to $6,250. 

Initial and maintenance margins (for those classified as hedgers) for Tier 1 heating oil futures (HO) are both increasing from $4,750 to $6,250.

Initial and maintenance margins (for those classified as hedgers) for Tier 1 RBOB gasoline futures (RB) are both increasing from $5,750 to $7,000.

Initial and maintenance margins (for those classified as hedgers) for Mont Belvieu LDH propane swap futures (B0) are both increasing from $2,750 to $3,500.

While this shouldn't come as a surprise given the recent volatility in the energy complex, (exchanges increase/decrease margin requirements on a semi-regular basis, in response to increases/decreases in volatility, as higher volatility increases the exchange members' clearing/default risk to one another), what this means is that the cost to hedge energy price risk is now higher than it was yesterday. 

While many energy producers, marketers and consumers execute the majority of their trades in the over-the-counter markets, margin increases on exchange traded products also impact the OTC markets as higher margin requirements increase OTC dealers cost of doing business.  In other words, if you are buying or selling OTC swaps or options, your dealer's (counterparty's) cost of hedging their own exposure has increased significantly, a cost that is generally passed on to you in the form of wider bid/ask spreads, hence the cost of hedging many energy commodities has increased, at least for the time being. 

In addition, while the margin increases only directly affect futures (and cleared swaps), they indirectly increase the margin requirements (as well as the subsequent capital requirements and hedging costs) for those selling options as well, as option market makers generally hedge their positions with futures.

While many argue that higher margin requirements are a "good" thing (the idea being that higher margin requirements would reduce speculation which would, in turn, lead to lower oil prices), this isn't necessarily the case (more on this in a future post). 

Coincidentally, or perhaps not, CNBC ran an article last week titled, Would Oil Prices Really Fall If Speculation Was Reined In, which concluded that higher margin requirements will do little to "rein" in speculators and/or lower prices, and we agree, as supply and demand, in due time, always sings the final song.  

We're a bit pressed for time this morning and will expand on the implications of higher margin requirements when time allows, but we thought it would be best to provide a brief overview sooner, rather than later.  In the meantime, the entire "advisory notice" from the CME is available via this link.  As always, if we can be of assistance please don't hesitate to contact us.