China is seeking to assert its growing influence on global oil markets with a yuan-denominated crude futures contract expected to be launched this year.
At the same time, analysts warn that the second-largest oil consumer after the US will struggle to compete with more established benchmarks such as London’s Brent North Sea crude and New York’s WTI.
“China is the world’s largest oil importer and is going to become the largest oil consumer in the future, so it makes sense for the country to be the place for an oil futures [contract] in Asia,” Xiamen University’s Energy Economics Research Center director Lin Boqiang (林伯強) told reporters.
China’s consumption will exceed that of the US by 2034, according to the US Energy Information Administration.
The nation produced about 4.6 million barrels per day of oil last year, while the country’s average net imports reached 6.1 million barrels per day.
The influence of Asia, and China in particular, has been growing on international commodity markets in recent times.
“China’s vision is to have these commodity markets priced on its own exchanges,” said Daniel Colover, associate editorial director at price reporting agency Platts.
It is also consistent with China’s gradual moves towards greater internationalization of its currency.
The Shanghai International Exchange is working on a final draft to be approved by the Chinese Securities Regulatory Commission before a comprehensive mock trading exercise.
Market participants expect an official launch by the end of the year.
The initial target of the new contract seems to be local companies and foreign companies with large interests in China, even if trading will be open to international players.
“Part of the reason China wants to launch this contract is to allow domestic hedging” that would protect against local price volatility, said Wiktor Bielski, global head of commodities research at VTB Capital.
However, the contract could struggle with liquidity, especially if it fails to attract foreign investors, because “there are not many players on the Chinese oil market, since the sector is highly monopolized,” Lin said.
The Chinese oil sector is dominated by national oil companies and even if some private companies have emerged, their scope remains limited.
“I don’t know why someone doing business outside China would be interested, given the longer-established, more transparent and more liquid alternatives are already available elsewhere,” said Julian Jessop, head of commodities at research group Capital Economics.
Two-thirds of the world’s oil is priced against the Brent benchmark.
Some gray areas remain around plans for the contract, in particular the crude which is going to be used as underlying instrument.
The derivative — or promise to take or make delivery of a volume of crude at a future date — will be based on a medium and sour crude, a quality favored in Asia and imported mainly from the Middle East. Thus supply will likely continue to be influenced by external factors.
“A lot of people in the industry — a cross section of the oil market, trading houses, oil majors, producers — are keen to see how it behaves and how it is adopted,” Colover said.
For Bielski, market adoption should not be a major hurdle.
In fact, volumes on the exchange could develop very quickly thanks to retail investments, he said.
Plans for smaller lot sizes — 100 barrels versus 1,000 for Brent — seems to be tailored to retail investors.
The iron ore futures contract on the Dalian Commodity Exchange, which influences the price of steel, did not trade for the first six months, but volumes then “exploded” on the back of “punters” trading, Bielski said.
In China, the amount of liquidity available to retail investors with money is growing faster than the number of products they can invest in, he added.
“What if that same thing happens to oil? Chinese markets are going to become more dominant and more importantly they are going to export contagion risk,” Bielski added.
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