ANALYSIS - Oil futures market opens up to black box trade

A woman fills petrol into her car at a filling station in Puchheim westward of Munich in this December 12, 2008 file photo.

LONDON/NEW YORK (Reuters) - Black boxes control only a small share of oil futures, but their reach is growing, driven by an influx of cross-asset dealers.

Those who rely on computer power to generate profit from split-second price moves vary from Wall Street banks to small hedge funds.

Their presence in oil trading began with the shift on oil futures markets towards electronic trade and has gathered momentum as volatility has risen and as fall-out from the financial crisis has given a spur to cross-asset deals.

"We have seen a solid increase of black box based trading in oil in the past couple of years. But oil is way, way behind other markets because it is a specialist market, it has physical trade," said Paul Zubulake, senior analyst with U.S. consulting firm Aite Group.

There are no official figures on the extent of high-frequency trading, which include black box and algorithmic trade, on the oil futures market, but Zubulake estimated it had risen to around 10 percent.

On U.S. equities markets, where electronic trading dates back to the 1970s, industry analysts say automated trading accounts for an estimated 60-70 percent of volume on U.S. equities markets.

Oil exchanges gradually introduced electronic trade over several years and the Atlanta based-InterContinental Exchange (ICE) went fully electronic in 2005. The New York Mercantile Exchange (NYMEX) still has open outcry trading, but bigger volumes are generated electronically.

A more recent spur has been this year's trading environment in which oil has been unusually tightly linked to bigger financial markets.

A prolonged equities rally set in around March, while the U.S. dollar began a steep slide as confidence in economic recovery drove investors away from relative safe havens and towards riskier assets.

Oil has risen in tandem with rising equities and a weakened dollar, which makes dollar-denominated oil relatively cheap.

NEW BREED

Some foreign exchange trading takes place on the electronic platform Globex, owned by the CME, where the volume of crude oil futures trade has been rising steadily.

Part of that volume is made up of a new breed of cross-asset dealers trading on the negative correlation between the dollar and oil.

"With the growth of electronic trading, more non-traditional energy related traders are involved in these markets than ever before," a U.S. based oil broker said.

For the traditional oil traders, it is good and bad. It generates liquidity, but it can exaggerate price trends, stoking a long-standing debate about the extent to which speculators rather than oil market fundamentals of supply and demand steer the market.

Volatility associated with speculators can in turn lure in more black box traders.

The oil market last year raced to a record of nearly $150 a barrel for U.S. crude , then crashed to below $33 a barrel in December. This year, it has rallied back above $80.

"The price volatility of oil in the past several years has attracted investors such as commodity funds and proprietary shops, who often tend to be black box based traders," said Andy Nybo, head of derivatives at U.S. research and advisory firm TABB Group.

"They are looking for new asset classes where they can deploy their trading strategy. More cross assset trading strategy will be generated by black box systems. It will grow to be a more important part of energy trading."

High frequency trading tends to be based on the breach of key technical levels or other non-fundamental triggers, but it can be a response to the kind of supply and demand data traditional oil traders follow.

"You can be a macro economic based trader, you can be a technical trader and you can be a fundamentally-oriented trader and use a black box. You just have to know how to teach fundamentals to your computer," Nybo said.

Some of the more traditional market players have been obliged to use it.

One physical oil trader, who uses the futures market to hedge forward positions, said NYMEX had become too fast to follow manually, so his team had switched to black box trade.

"We decided to let the machine do the trading," said the dealer, who asked not to be named.

(Editing by Barbara Lewis and Sue Thomas)

(For more news on Reuters Money visit www.reutersmoney.in)