China’s yuan-denominated oil futures - what took you so long?
As a young Financial Times foreign correspondent in the late 1970s, one of the darkest and most exotic news pools for understanding China was the commodities markets.
You would wake up one morning to find news agency reports from the London Metal Exchange (LME) or the Chicago Mercantile Exchange (CME), that world copper prices had inexplicably jumped, or that iron ore futures or wheat contracts had suddenly gone crazy, and no one clearly knew why.
The talk was always of mysterious buyers, opaquely linked with Chinese ministries, or secretive state-owned enterprises. We speculated on possible shortages inside then-profoundly closed China, or some shift in mainland Chinese industrial policies.
Forty years later, China still keeps the world’s commodities traders in thrall, and more than ever has the power both as a buyer or seller to move markets.
Dealing is not quite so opaque – though Beijing officials still move highly secretively in the certain knowledge that the second commodities traders learn that China is in the market for iron ore, or soya meal, a speculative frenzy will ensue.
So the launch this week of China oil futures contracts, tradeable in renminbi on the Shanghai International Energy Exchange, with international commodities traders for the first time being allowed to buy and sell, is a significant development. Shocking - more than anything else - is how long it has taken.
While the CME remains the world’s leading commodities trading market, accounting for around 34 per cent of the 25 billion commodities futures and options contracts traded last year, and the NSE India exchange is number two, it should be no surprise that China has emerged to become one of the world’s largest and most active futures trading markets.
As the world’s main producer of many farm products, the biggest importer of oil and gas, most metals and agricultural commodities, it could hardly be otherwise.
From the opening of the Zhengzhou Commodities Exchange in 1990, the Dalian exchange in 1993 and the Shanghai Futures Exchange in 1999 (add in the China Financial Futures Exchange in 2006, if you want to include trading in equities, interest rates and exchange rates) commodities futures contracts in China last year amounted to US$25 trillion – more than twice China’s gross domestic product.
Until this week, commodities trading inside China has been almost entirely a local affair. Contracts are denominated in the country’s currency, with the volumes of activity providing a glimpse into the massive speculative urges awash across this increasingly affluent economy.
Look at apples futures contracts, introduced last December, as a way of stabilising the incomes of China’s apple farmers concentrated in the country’s impoverished north east. The contract was an “insurance plus futures” arrangement to ensure that (for a small premium) farmers could be certain of a minimum floor price for their apples. It was part of Beijing’s san nong (three farming) strategy aimed at lifting rural livelihoods.
Reports of rising global demand for apples, coupled with reports of bad growing seasons in both Europe and the US, sent the market into a frenzy two weeks ago. In a single febrile four-hour trading session, 964,000 contracts – each worth 10 tonnes of apples – were traded.
That was 9.6 million tonnes, worth US$11 billion, amounting to the sale and purchase of 60 billion apples. Note that the total global production of apples last year was 76 million tonnes, with 57 per cent of these grown in China, and just 1.3 million tonnes exported. For sure, not many Chinese farmers were involved in this futures feeding frenzy.
Of course, the significant majority of futures and options trading worldwide has nothing to do with farms or products.
According to the US-based Futures Industry Association, almost half of last year’s 25.2 billion futures and options contracts were related to equities, with a further 28 per cent focused on interest rate and currency contracts. After contracts focused on oil and natural gas, and on a wide array of metals, just 5 per cent of the total – about 1.3 billion contracts – were based on farm products ranging from coffee and canola to soya meal and pork bellies.
But for sure, China is playing a progressively more significant role in futures trading, not just in traditional sectors, but in a wide range of new ones too.
And the opening up of the market to foreign traders this week may prove to be a giant step forward in China’s role. Growth among international participants is likely to remain constrained, not just because of capital controls and regulatory risks, but also because the contracts are being traded in renminbi – as far as I can see, a quite deliberate effort by Beijing to reduce the US dollar’s hegemony over the pricing of world commodities prices over time.
While, as with the rest of the world, traditional trading is focused on equities products, interest rate contracts, and oil and natural gas contracts, a lot of China’s commodities trading activity has developed to be very specific to China’s own economy, and its trading needs.
A total of 27 new futures contracts have been created in the past five years, for products ranging from white sugar and soya meal, to asphalt. While pigs and pork bellies have been a staple for the Chicago exchange probably since it was first opened in 1848, China is adding paper pulp, cotton yarn and jujube – or red dates – a staple for the Chinese as a snack and in teas for centuries.
The Zhengzhou exchange in Henan on the banks of the Yellow River must surely be a natural home for jujube trading.
It is one of China’s main centres not just for the production of red dates, but also tobacco, maize, pomegranates, garlic and persimmons. I can smell garlic futures wafting our way very soon.
David Dodwell researches and writes about global, regional and Hong Kong challenges from a Hong Kong point of view