UNITED STATES OF AMERICA 

COMMODITY fUTURES TRADING COMMISSION 

2033 K Street. N.W. 

Washington; D.C. 20581 

April 25, · 1990 

Dear 

. This is in response to your March 2 and March 30, · 1990 

letters to the Commission's General Counsel on behalf of your 

clients, Company A ("A"),· Company B ( "B") and Company C ( "C"). 

In your letters, you.seek the Commission's staff's views 

concerning the light "sweet" crude oil ("crude oil") contracts 

(the "Contracts") described below; the execution and performance 

of the Contracts and related crude oil transacuions by A, c, the 

Trustee, acting on behalf of the Trust, and the Adviser, as 

described below; and the offer and sale of, and secondary market 

transactions in, Trust units by B and others, as described below. 

! 

Based upon your letter, we understand the following. 

The Parties 

A is a •.. corporation. Through its subsidiaries, A 

provides worldwide diversified financial services to and trades 

with major corporations, governments, supranational 

organizations, central banks and other financial institutions. C 

and B are wholly-owned subsidiaries of A incorporated in the 

State of • • • • 

C is, among other things, one of the world's largest 

international traders of energy-related commodities, including 

crude oil, oil products, petrochemicals, plastics,. coal and coke. 

B is a major securities broker/dealer registered with 

the Securities and Exchange Commission· and a futures commission 

merchant registered with the Commission. 

selected 

or trust 

million. 

The Trust 

: ···: .. 

The Trustee for these transactions has not been 

at this time. However, the Trustee will be a U.S. bank 

company with capital and surplus in excess of $ . . . 

The Trustee will not be affiliated with A, C or B. 

The trust (the "Trust") will be created under the laws 

of a state to be selected pursuant to a declaration of trust made 
.. . 

' 

. 

··. 

2 

by the Trustee. It is intended that the Trust be operated in a 

manner qualifying the Trust as a "grantor trust" for U.S. federal 

income tax purposes. 

The Trust will issue certificates of beneficial 

interest ("Trust units") to investors in a public offering 

registered under th~ Securities Act of 1933, as amended (t~e 

"Securities Act") • .l/ B will underwrite the offering of Trust 

units.~/ It has not been determined at this time whether the 

Trust units will be listed for trading on a national securities 

exchange.· 

The proceeds of the offering will be delivered to C in 

exchange for the Contracts described below, which will be 

deposited in the Trust.dl The Contracts will be entered into by 

C and guaranteed by A or will be entered into by A in which case 

A will delegate its obligations thereunder to C but will remain 

liable therefor to the Trust. The Trust will not enter into· any 

other contracts relating to the purchase or sale of a commodity, 

other than the Contracts and related transactions described 

herein, including without limitation, any futures contract or 

commodity option contract. 

The Contracts 

As noted above, 

oil to be delivered under 

at the time the Contracts 

the sale of Trust units. 

payments made by either A 

the full purchase price of the crude 

the Contracts will be paid by the Trust 

are entered into from the proceeds of 

There will be no variation margin 

or the Trust at any time. 

A series of • • • separate Contracts will be entered 

into between C and the Trust each of which will provide for 

delivery of crude oil by C to the Trust during one of • . • 

consecutive . • • • Each Contract will require the delivery of 

the crude oil to the Trust on a • . • basis to be made at the 

. . . pipeline facility in . . • . The number of barrels of oil 

to be delivered during each ••. delivery month (each~ a 

"Delivery Month") will be determined in accordance with the 

.llrt is possible that the Trust units will be sold in a private 

placement under section 4(2) of the Securities Act. 

~lrt is possible that other registered broker/dealers will 

participate in the distribution of Trust units. 

diThe deposit of the Contract in the Trust may take place through 

a special purpose subsidiary of A. The parties to the Contract 

held by the Trust will not be affected by this arrangement. 
I 

< 

3 

formula described below by reference to (1) the average o£ the 

future settlement prices (each such price, a "Settlement Price") 

'of the New York Mercantile Exchange light "sweet" CJ;"Ude oil 

futures contract for the then • • • delivery month±! during the 

••• (a " ••• Reference Period") commencing ••• months 

preceding the Delivery Month and (2) the average of the 

Settlement Prices during the ••• period (each a "• • • . 

Reference Period") immediately following the ••• Reference 

Period. Very generally, the number of bar~els of oil to be 

delivered during any Delivery Month will increase, within a 

range, in relation to increases in the average Settlement Price. 

Subject to a minimum delivery of • • • barrels, the 

number of barrels of oil deliverable under each of the • • • 

Contracts during the Delivery Month for each of the • • • 

consecutive ••• will be equal to the product of (a) • 

barrels, multiplied by (b) a fraction, the numerator of which 

will equal the applicable ••• Reference Price minus $ .• ·• , and the denominator of which will equal the product of the • • • 

Reference Price and the • • • Reference Price. Assuming the 

• • • Reference Price, the • • • Reference Price and the price 

at which the oil is sold by the Trust are equal, the operation of 

this formula will impose a maximum • • • d~livery limitation of 

• • • barrels of crude oil per Contract.~/ 

Very generally, under the formula described above, 

decreases and increases in the price of crude oil above current 

market prices produce a decrease and increase, respectively, in 

the number of barrels of crude oil to be delivered under the 

Contracts. However, once a certain price level is reached 

($ ••• per barrel under current market conditions), further 

increases in the price of crude oil result in corresponding 

decreases in the number of barrels of crude.oil to be delivered 

at a rate which, in essence, progress}vely reduces the rate of 

increase in the return to the Trust.~ 

±/Alternative price determination mechanisms and sources will be 

utilized in the event that a settlement price for the New York 

Mercantile Exchange futures contract.described above becomes 

unavailable for any reason. 

~/The number of barrels of crude oil us-~d in the formulas and 

prices referenced in this letter are based on current market 

conditions and are used for illustrative purposes. The actual 

numbers used will be based on market conditions prevailing at the 

time of the offering of the Trust units. 

~/The relationship between the price of Crude Oil, the number 

(Footnote Continued) 
4 

In addition, it is possible that, in order to increase 

the minimum return in the ••• years, the ••• Reference Price 

'used in the formula to determine the number of barrels to be 

delivered during the • • • deliveries may be given a minimum 

value, currently expected to range between $ .•• and $ .•• 

per barrel. The formula would operate identically to the 

original proposal, except that, if the • • • Reference Price were 

less than the minimum value at any time during the • • • years, 

the value of the • • • Reference Price for purposes of the 

formula would instead be deemed to be the minimum value. 

The delivery of crude oil under the Contracts will be 

governed by • • • Tariff, effective ••• , as amended from time 

to time. 

Delivery under the Contracts will be mandatory and 

neither C nor the Trust intend, or shall have the right to elect, 

cash settlement, offset, assignment or other alternative methods 

of <iischarging obligations under the Contract. Even in the case 

of events in the nature of forgg majeure beyond the control of 

the parties, the delivery obligation will be delayed without 

liability for damages, but will not be excused. 

Operation of the Trust 

The Trustee will engage an advisor (the "Adviser"), 

unaffiliated with A, c, B and the Trustee, that is experienced in 

dealings in crude oil to assist it in administering arrangements 

relating to the receipt and sale of crude oil delivered under the 

Contracts. 

Immediately following each • • • Reference Period, A or 

C will notify the Advisor and the Trustee of the applicable • • • 

Reference Price, • • • Reference Price and the resulting number 

of barrels of crude oil to be delivered to the Trust during the 

applicable Delivery Month. The Advisor will assist the Trustee 

in soliciting bids from third-party crude oil traders and dealers 

(having satisfactory credit ratings) to purchase such crude oil 

from thl Trust for delivery to the purchaser during such Delivery 

Month,L requesting quotes based on the average of the Settlement 

(Footnote Continued) ., . 

of barrels delivered and the return to the Trust assume that the 

Reference.Price, ••• Reference Price and sale price for 

each Delivery month are equal. Variations in these prices will 

have differing effects based on the direction and magnitude of 

the differences. 

L/Delivery of crude oil through the ..• facility during any 

(Footnote Continued) 
' •. 

5 

Prices during the • • • period following the date of solicitation 

(The "Selling Period"). The Trustee will be required to sell the 

'Trust's crude oil to the highest bidder and the adviser will 

assist the Trustee in arranging such sales and scheduling the 

delivery of such crude oil. Payment for crude oil sold on behalf 

of the Trust will be required on or about the 20th day of the 

calendar month following the Delivery Month. 

If for any reason during any Selling Period the Trust 

does not receive a.bid for the crude oil to be delivered during 

the following Delivery Month at a price equal to or greater than 

the average Settlement Price during the Selling Period less ten 

cents ($0.10) per barrel, then ••• will agree to purchase such 

crude oil from the Trust at that price for delivery during that 

Delivery Month. 

The Advisor will receive a fee for its services, which 

will be negotiated prior to the creation of the Trust. In 

addition, the Trust will incur all of the normal costs and risks 

associated with taking and making delivery of crude oil. 

Net proceeds from the sale of the crude oil on behalf 

of the Trust will be remitted to Trust unit holders shortly 

following the Trustee's receipt thereof, in accordance with the 

requirements of the declaration of trust. 

Based on this information, it is the staff's· view that 

the minimum price guarantee aspect of the Contracts creates the 

risk/return characteristics of a cash-settled call option by 

placing a floor on the Trust's return based on the sale of crude 

oil. That option characteristic, however, is embedded in the 

Contracts which require that the crude oil be delivered within 

normal commercial marketing channels. This delivery is requLred 

under all circumstances. 

Although the Contracts require delivery of the crude 

oil, unlike a cash forward contract, the ultimate purchaser of 

the crude oil from the Trust is undetermined at the time the 

Contracts are entered into and is not itself a party to the 

Contracts. These features, among others, distinguish the 

Contracts from those instruments discussed in an Interpretative 

Statement of the Office of the General Counsel, "Characteristics 

(Footnote Continued) 

month is scheduled over the course of the entire month, rather 

than on any particular day. 
-----,----~~~~-

6 

Distinguishing Cash and Forward Contracts g.nd 'Trade' Options" 

(50 Fed. Reg. 3956 (September 30, 1987)).~/ 

In light of the representations in your letter, and in 

particular the fact that under the Contracts, C will be obligated 

to deliver crude oil in normal commercial channels, the staff 

will not recommend to the Commission any enforcement action under 

Sections 4(a) or 4c of the Commodity Exchange Act, 7 U.S.C~§§ 

6(a), 6c, or Commission Rule 32.11, 17 C.F.R. §32.11 (1989), 

based upon the execution and performance of the Contacts and 

related crude oil transactions by A, C, the Trustee acting on 

behalf of the Trust, and the Advisor, as described above, and the 

offer and sale of, and secondary market transactions in, Trust 

units by B and others, as described above. This position does 

not excuse A, c, B, the Trustee or the Advisor from complying 

with any otherwise applicable provisions of the Commodity 

Exchange Act or Commission regulations, nor does it address any 

other proposed instrument. Any different, omitted or changed 

facts or conditions might require a different conclusion. It 

should also be noted that this position is that of the staff and 

is not binding upon the Commission. 

Sincerely, 

Joanne T. Medero 

Andrea M. Corcoran 

Co-Chairmen 

Off-Exchange Task Force 

. •'. ~ . 

~/This interpretative statement explains, among things, that 

certain minimum price forward contracts which have certain 

characteristics of option contracts will be considered to be cash 

forward contracts where the contract requires actual delivery of 

the commodity in which the forward commitment is made in normal 

commercial channels.