BEIJING: China may have become the world’s largest importer of crude oil in April, but there is one thing it still lacks, its own oil market.
That could change this year if the Shanghai International Energy Exchange Ltd., also known as INE, launches a long-planned oil-futures contract in Shanghai’s free-trade zone. Yang Maijun, the chairman of the Shanghai Futures Exchange, one of the partners in INE, said earlier this year that trading in the new oil contract could begin in 2015.
The establishment of an oil-futures market in China could prove another milestone in what analysts at Macquarie Group Ltd. recently called a “seismic shift in futures-trading firepower from West to East” in commodities markets. Already, the volume of metals futures traded on Chinese exchanges at times eclipses volumes on the London Metal Exchange, according to Macquarie. Ten of the 20 agricultural commodity contracts that had the most trading volume in 2014 were on Chinese exchanges.
But the planned Shanghai oil market’s success will depend on how well it satisfies two potentially conflicting aims.
The INE wants to tap huge potential interest from Chinese individual investors, who have poured billions of yuan into domestic markets for commodities from iron ore to soybeans in recent years. It also hopes its new oil contract will eventually stand alongside the U.S.’s West Texas Intermediate and the U.K.’s Brent futures as a key global oil-price benchmark, albeit one that better reflects Asian market conditions.
To that end, Shanghai’s oil futures will be the first Chinese commodities market fully open for trading to foreign investors. “China is looking to attract liquidity from local participants…whilst creating an internationally accessible contact through the international free zone setup in Shanghai,” said Tom James, energy consultant at the Renovatio Commodity and Energy Fund.
Establishing a truly global oil-futures market won’t be easy. To start with, China’s new product won’t be priced in dollars, the industry’s standard currency.
Instead, contracts will be denominated in China’s currency to appeal to domestic individual investors. For the same reason, the Shanghai futures will be based on lots of 100 barrels of oil, smaller than most other globally traded oil futures, which are based on 1,000 barrels. For foreigners, investing in a yuan-denominated contract will mean betting not only on oil but also taking on currency risk.
Even attracting domestic investors may be hard, given the resurgent popularity of Chinese stocks. “Chinese equity markets have become more investible in many ways because of the relative preference of domestic investors, as the commodity supercycle comes to an end,” said Sriram Vasudevan, managing director at hedge fund Graticule Asset Management Asia Pte. Ltd.
Meanwhile, big Chinese state-owned firms, including big oil companies, face restrictions on how much trading in futures they can do. And despite some recent relaxation of the rules, only a handful of companies are allowed to import oil, meaning industrial demand for the new oil futures may be limited.
Trading volumes on Chinese commodity exchanges have primarily been driven by institutional and private investors who are mainly involved in short-term trading.
