=DJ ICAP's New Derivatives Have The US Gas Market's Number
 
   By Spencer Jakab 
   Of DOW JONES NEWSWIRES 
 

  NEW YORK (Dow Jones)--Two months ago, when ICAP Energy and the New York
Mercantile Exchange launched derivatives that allowed traders to bet each week
on the outcome of the U.S. Department of Energy's natural gas storage survey,
reactions from energy analysts and traders were at best mixed. 

  After all, the closely watched storage number already can make or lose traders
big money in the natural gas futures market. Placing additional wagers on the
outcome of the underlying indicator itself seemed to be a bit, well, speculative
- even for speculators. 

  "It's pure gambling," said one veteran natural gas watcher who uses a
sophisticated model to produce his own weekly estimate of the storage number. 

  But after its first eight weeks, the Wednesday afternoon auction is receiving
a flurry of interest both as a financial instrument and as a surprisingly
accurate way of predicting the Energy Department's data, the gas market's most
important indicator. 

  The numbers generated by the auction have varied from those reported by the
Energy Department the following day by just 3.9%. In the same period, forecasts
made by six of the best-known gas gurus missed by 5.8% to 12.4%. Dow Jones
Newswires' survey, which averages forecasts made by some three dozen analysts
and traders, was off by an average of 7.1%. 
 
     Man Vs Money 
 

  The analysts trying to forecast weekly changes in U.S. gas in storage are no
intellectual lightweights. They spend much of their day dissecting pipeline
receipts, weather statistics, rig counts, power plant outages, nuclear plant
capacity utilization, hydroelectric dam water levels and similar minutiae. They
feed these into computerized models primed with years of historical data, and
they mix in a gut feel developed during years of experience in the industry. 

  The ICAP-Nymex auction, on the other hand, just gives traders an opportunity
to buy or sell products that take their value from where the storage number
comes out. They include outright bets on a storage number, options that pay the
difference between the strike price and the actual outcome, and forward
contracts that allow buyers to lock in a storage level. The various financial
bets combine to generate an indicative price that corresponds to a storage
estimate. 

  So is it just a glitch that the gamblers are winning? 

  "I don't think it's a glitch," said Robin Hanson, an assistant professor of
economics at George Mason University and an expert on decision markets. "I
believe it'll continue." 

  Hanson was associated with one of the highest-profile experiments in the
decision-markets field the aborted Policy Analysis Market touted by a group
within the Pentagon to more accurately predict geopolitical risks by creating a
financial futures market in geopolitical events such as political turmoil or
terrorist attacks. 

  Although the idea of such a market struck the public as morbid, leading to
disavowals at the highest levels of government, experts point out that it could
have been a useful tool. Similar markets in other arenas are uncannily accurate.


  Take the Iowa Electronic Marketplace, which 76% of the time since 1988 has
done a better job than opinion polls of predicting the outcome of presidential
elections (on Thursday, the market had Bush and Kerry in a dead heat).
Participants in the market, who essentially place bets on which candidate will
win, may not be representative of typical voters. They may not even vote. But
that doesn't matter. 

  "We've found that our markets tend to predict election outcomes better than
polls," said Joyce Berg, an associate professor at the Tippie College of
Business at the University of Iowa and a director of the program. 

  "In surveys and polls, people don't have an explicit requirement to be
accurate and honest," she explained. "In a market, people express strength of
belief." 
 
     Expansion Plans 
 

  ICAP Energy is naturally pleased with the results so far. "It's been quite
interesting how accurate the auction has been," said Patrick Morgan, who
administers the auction. "It's been increasing in terms of participation and
some of the order sizes that have gone through." 

  ICAP executives say they are planning to expand the auction to include options
on storage volumes at the end of the injection and withdrawal seasons for
natural gas - Nov. 1 and April 1, respectively. 

  They also plan to launch an auction on the Energy Department's crude oil
inventory survey later this year, opening up a potentially larger and more
volatile market. Forecasts of that number tend to range more widely than they do
for gas and can vary substantially from the actual number each week. 

  If the ICAP auction remains an effective predictor of the Energy Department's
gas number during the critical winter heating months, it may take on added
importance. Swings in those months are bigger, and traditional forecasts tend to
vary more then from the actual number. 

  Ironically, the auction may give highly sophisticated individual forecasters
an additional raison d'etre. The gas market may or may not reward an accurate
call on the Department of Energy's number, but the ICAP auction will. 

  "It's providing an opportunity for some institutions to monetize their
research," Morgan said. Indeed, those quantitative types toiling in the
background now receiving a paycheck and pat on the back for making a good stab
at the weekly storage number could soon turn into the real stars of the
business, just as they have in markets like fixed income. 

  "It's real money at stake, and there's real money to be made," Hanson said. 

  -By Spencer Jakab, Dow Jones Newswires; 201-938-4377;
spencer.jakab@dowjones.com 
 

  (END) Dow Jones Newswires

  07-30-04 1528ET