Middle East Uprisings Highlight the Importance of Supply Margin

Crude and its refined products, like any commodity, are ultimately priced on supply and demand. Sounds simple enough. The one complication added to these pricing inputs; expectation of future supply and demand. The sharp run up in crude prices the past few weeks shows how big a role expected supply and demand plays. The one buffer that will temper or exasperate expectations is spare production capacity.

No one really knows for sure how the problems in North Africa and Middle Eastern countries will resolve. We could experience a swift and peaceful change of these governments to stable democracies, continued prolonged unrest, or a combination of the two. What is known is the world is consuming 88 million bbls per day, up 2.7 million bbls per day from last year and expected to grow an additional 1.7 million bbls per day this year. At current crude production rates there are 4 to 5 millions bbls per day of spare capacity.

Even without turmoil in the Arab countries, the rising world demand for crude will cut into spare production margin bringing it down to 3 million bbls per day. Factor in potential production disruptions and the world could easily find itself with fuel supply shortages.

The narrowing of marginal crude production capacity is what is driving crude to multi year highs. Until more crude production capacity is added, or world economies collapse under the weight of higher crude prices, expectations will remain for supply not being able to outpace demand.

Will the Chicago Markets Follow the Deutsche Borse NYSE Lead?

The transformation of global capital markets ramped up quickly this week with the disclosure of Deutsche Borse in talks to acquire NYSE Euronext. Should the proposed merger be approved, the combined entity will dominate derivatives trading in Europe and America and has the potential of dominating stock trading. Germany will become the epicenter of global capital markets.

The driving forces behind the merger are economies of scale and market share. Trading system costs and regulatory expenses will be reduced in direct relation to scale of trading volume. The combined Deutsche Borse/NYSE will be an unassailable global market share growth monster dominating both continents. Costs will be reduced and pricing power will increase as competition evaporates.

How are the Chicago exchanges along with Nasdaq going to compete against this new dominant force? Joining forces and fighting to keep and expand market share appears to be the best solution.

The Chicago Mercantile Exchange already dominates US futures trading. Increased trading volume will have to come from growth in Europe. Nasdaq has an exchange in Sweden, but will find it very difficult to grow in Europe with a combined Deutsche Borse/NYSE.

The Chicago Board of Exchange, CBOE, is the largest US options mart, with several extremely valuable, exclusively traded large volume options. Because of its US options dominance, the CBOE is a very likely, though very expensive, take over target.

A combined Nasdaq, CME, CBOE, with perhaps an Asian exchange added, would make a formidable competitor to a united Deutsche Borse/ NYSE.

Deal makers will probably wait to see if the proposed Deutsch Borse/ NYSE merger becomes reality. If and when it does, additional exchange market merger announcements will be forth coming.