China aims for pricing power in launching crude oil futures

Long-awaited crude oil futures may debut in the second-half of 2017 with simulated trading being conducted

PUBLISHED : Saturday, 22 July, 2017, 12:01pm
UPDATED : Saturday, 22 July, 2017, 12:01pm

China could well be on its way to the launch of the country’s most significant commodity futures as the Shanghai Futures Exchange has started vetting applications from brokerages to conduct crude oil futures business.

The long-awaited crude oil futures contract is likely to make its trading debut in the next few months, as regulators and exchange officials are putting final touches on the trading system with simulated trading already underway.

By the end of May, 92 members have been accepted by the Shanghai International Energy Exchange to offer brokerage services to crude oil futures traders.

In the next phase, the energy exchange will continue to review warehouses, custodian banks and inspection organisations before certifying them to offer related services to participants in crude oil futures trading, it said in a statement.

The energy exchange, a wholly-owned subsidiary of the Shanghai Futures Exchange with a 5 billion yuan (US$735.2 million) investment, was established in the Shanghai free-trade zone in 2013.

Sources with knowledge of the preparations for the yuan-denominated crude oil benchmark said an official launch would take place in the second half of 2017.

“It will be more than a milestone in China’s futures market when the contract starts trading,” said Huang Lei, an independent commodity futures analyst. “But those who expect the contract to become an Asia benchmark might feel disappointed.”

Crude oil futures will be the first commodity futures contract on the mainland that allows trading by foreign investors.

Major global oil companies such as Exxon Mobil and BP are expected to participate in trading of the yuan-denominated contract, but the extent of their interests remains to be seen.

But those who expect the contract to become an Asia benchmark might feel disappointed
Huang Lei, analyst

To secure its bargaining power to price oil, a significant energy source, Beijing started nearly seven years ago to prepare for the launch of China’s own crude oil futures.

It was not until December 2014 that the State Council officially approved the trading platform established by the Shanghai Futures Exchange in the city’s free-trade zone to list the contracts, which would for the first time invite foreign investors to trade mainland commodity futures.

It was expected then that trading could start within 2015 after crude oil futures received the go-ahead from the cabinet.

But the ambition to create a premier price benchmark for oil traded in Asia hit a blip in mid-2015 as the Shanghai Futures Exchange backed down on the plan for an imminent launch of the energy contract.

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A lack of interest by foreign investors was believed to be one of the main reasons for the delay.

Beijing also had to draw up a complete set of regulations governing the trading of the energy contract to attract foreign traders.

Foreign currency conversion, warehousing and tax rates were other sticking points that held back a trading launch.

China, the world’s largest net oil importer and the world’s second-largest economy, is convinced that a lack of pricing power in the global oil market had caused it to be a main victim of the volatility in oil prices years ago.

China would have to attract foreign investors, including explorers, refiners, users and traders to take part in trading of the contracts to pave the way to eventually create a premier price benchmark.

World crude oil prices are set by the New York Mercantile Exchange and in London, normally through the benchmark WTI price, and in comparison with the Brent price.

In Asia, Singapore is the established regional oil market, while the Shanghai bourse could likely become a rival with the city-state in gaining pricing power in the region.

Other important prices for oil are Dubai crude, Oman crude and the Organisation of Petroleum Exporting Countries reference basket.

Crude oil sold in Asia is mainly priced against the Dubai, Oman and dated Brent benchmarks assessed by S&P Global Platts or the Oman crude futures on Dubai Mercantile Exchange.

“Crude is certainly the most important commodity that China wants to have a say in pricing it,” said Wang Feng, chairman of Shanghai-based financial services firm Ye Lang Capital. “China needs its own oil price benchmark to avoid suffering losses from volatility in global oil prices.”

Industry officials in China contended that global oil giants would not necessarily need to play crude oil futures on the mainland market amid difficulties arising from logistics, currency control and the lack of experience in the country’s roller-coast securities markets.

Beijing has trodden cautiously with a go-slow approach in liberalising the futures market, where chaotic trading and scandals have plagued the earlier stages of its development.

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Still, official have shown a willingness to commit to the development of the crude oil futures market as the country’s influence on the global economy grows.

China needs its own oil price benchmark to avoid suffering losses from volatility in global oil prices.
Wang Feng, Ye Lang Capital

Futures are an agreement to deliver or take delivery of a commodity or financial instrument at a certain date and price, and are used as a hedging tool against price volatility.

Active trading of crude oil futures in Shanghai would technically help local oil producers, refiners, downstream companies to effectively dodge unnecessary losses from big swings in global oil prices.

The debut of crude futures also will give a shot in the arm to Shanghai’s free-trade zone, where the trading will be conducted, as criticism mounted that the zone has achieved little since it opened in September last year.

Bi Sheng, an oil trader with China National United Oil, a unit of the country’s biggest energy company CNPC, said the surging demand for crude oil in Asia led to accelerated efforts by the regional economies to gain pricing power for the energy source.

As the world’s largest energy consumer, China’s imports of crude oil account for more than 60 per cent of its total consumption.

But its own output is not large enough to attract global traders, said a senior executive with a privately-owned oil company, who declined to be identified.

If the powerful players already have the established markets in New York or London to trade for hedging purposes, they would not see the necessity to actively trade the yuan-denominated contracts, he added.

“Many foreign investors are still battered by fears that the casino-like exchanges in China would cause them losses,” said Huang. “It will take at least 20 to 30 years before Shanghai can have an Asia oil benchmark.”

In 1993, Beijing launched oil futures in Shanghai but halted the trading one and a half years later due to volatile trading.

In February 1995, Shanghai Wanguo Securities massively exceeded a ceiling on its futures position and dragged down prices of a bond futures contract.

This resulted in the suspension of trading in bond futures, and the government eventually had to cover Wanguo’s losses. That scar has remained.