NASDAQ OMX To Launch Energy Derivatives To Compete With ICE, CME

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NASDAQ OMX Group (NASDAQ:NDAQ) announced that it will expand its offerings to include energy futures and options from mid-2015. In the last few months, the exchange operator has pitched offerings to and secured support from some major banks, clearing firms and brokerages to help boost trade volumes. [1] The main aim behind venturing into energy derivatives is to grab share from existing market leaders such as the CME Group (NASDAQ:CME) and the IntercontinentalExchange Group (NYSE:ICE). NASDAQ will offer trading products based on natural gas, oil and power benchmarks, which will be collectively referred to as NASDAQ Energy Futures.

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NASDAQ Energy Futures

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NASDAQ OMX is one of the most well-diversified global stock market operators, with trading products ranging from equities, derivatives, exchange traded funds and fixed income products. The company currently offers equity trading, equity derivatives and fixed income products in the U.S. NASDAQ’s management made the decision to start offering energy futures and options due to the vast potential in the domain, in which ICE and CME enjoy a near duopoly. The company intends to bring down the present “monopolistic environment” by offering better prices and clearing services. [2]

NASDAQ plans to cut existing prices by up to 50% and has found active participants in some of the top financial institutions such as Goldman Sachs, JP Morgan, ABN Amro, Morgan Stanley, Advantage Futures LLC and Virtu Financial LLC. These firms and institutions collectively account for about 85% of the trading volume in this market. [1] The energy contracts to be offered are similar to those offered by ICE and CME, with the exception of getting products physically delivered. The company will use one of the futures exchanges that it acquired during its acquisition of Philadelphia Stock Exchange (PHLX) back in 2007. [2]

CME has posted trade volumes of about 1.6-1.7 million energy contracts per day over the last few years, which roughly translates to about 400-430 million energy futures and options traded in a calendar year. CME has historically charged its customers somewhere between $1.30 and $1.50 per energy contract traded. Similarly, the total number of energy futures and options traded on ICE’s American platform stood at 250 million contracts in 2014, down from over 320 million contracts in 2013.

NASDAQ intends to grab about 10% of the energy derivatives market over the next couple of years, which could lead to trade volumes of about 80-100 million contracts traded per year. Moreover, since the company wants to significantly undercut competition, it could realize an average revenue per trade of as low as $0.70-$0.80 per traded contract. It could potentially boost NASDAQ’s top line by as much as $80 million in 2016. According to the company’s statement, a 10% gain in market share could add about $5o million to the company’s bottom line through 2016. [2] Although it seems optimistic at the moment, sustained growth in energy derivatives trading could help the exchange operator generate significant revenues. Energy derivatives trading has been on the upswing since late 2014 owing to volatility in oil prices.

In 2014, NASDAQ OMX generated revenue of $525 million from derivatives trading in the U.S, up from $514 million in 2013. The average fee charged per contract stood at around $0.50 for the exchange operator. The potential rise in energy derivatives trading could lead to higher revenues and profits for NASDAQ, while it could also lead competitors to decrease prices. We currently forecast NASDAQ’s U.S. derivatives revenue stream to grow at about 3-4% annually in the next few years. There could be  a 3-4% upside to our $45 price estimate for NASDAQ OMX if the rate of growth goes up to 8-9% a year in the coming years. Our price estimate is about 10% lower than the current market price, which has risen by over 10% since the company reported its Q4 earnings in late January.

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Notes:
  1. Nasdaq to challenge ICE and CME with new energy futures market, Reuters, March 2015 [] []
  2. Nasdaq to Launch Energy Futures Market, Wall Street Journal, March 2015 [] [] []