China’s Oil Futures Give New York and London a Run for Their Money

29 Mar, 2019 23:58
source: WSJ

Despite a surge in volumes, most trading in yuan-based contracts has been initiated by Chinese, rather than foreign players

SHANGHAI—A year after China rolled out yuan-denominated oil futures to shake up the global crude market, trading in the new contracts is gaining ground on rivals in London and New York.

But despite a surge in volumes, market participants say most trading in the yuan-based contracts has been initiated by domestic, rather than foreign players. That suggests China still has a way to go before oil futures in Shanghai can become a truly international benchmark.

China is the world’s largest importer of crude oil. Last March it launched its own oil market to establish prices in its own currency and to better reflect domestic demand and supply conditions. Another goal was to reduce the country’s dependence on the dollar-based global oil trading system.

Daily trading volume of front-month crude oil futures on the Shanghai International Energy Exchange averaged around 248.5 million barrels of oil in January 2019. They made up roughly a fifth of global trading in similar contracts and were close to trading volumes in Brent front-month oil contracts in London, according to data from Wind Info., ICE Futures Europe and CME Group

More recently, the benchmark Shanghai contract’s trading volume has comprised around 14% of the global activity in similar futures, or about half that of Brent’s. The bulk of crude-oil trading still takes place in the U.S., where the benchmark is the West Texas Intermediate contract.

“It’s an important long-term step in the development of a global oil market,” Michael McCarthy, chief market strategist at CMC Markets in Australia, said of the Shanghai oil contracts. “The fact that it reflects the collective view of traders and investors in China is by itself important given the size of the Chinese economy,” he added.

Longstanding structural issues plaguing China’s oil industry, from the virtual monopoly of the nation’s top three state-run producers to the government’s firm grip on pricing, however, could hinder Beijing’s effort to foster a vibrant futures market.

The rollout of Shanghai oil futures followed years of planning and they are a key part of Beijing’s broader strategy to gain clout in global oil trade and turn the yuan into a credible challenger to the dollar.

So far, the vast majority of trading in this new contract has come from Chinese oil producers, consumers and traders, according to market participants. In U.S. dollar terms, prices of the Chinese futures have also generally tracked their rivals over the past year.

The Shanghai benchmark contract traded at 458.8 yuan ($68.27) per barrel
Wednesday, compared with $67.63 for Brent and $59.92 for WTI. Oil prices are up about 27.7% this year.

Foreign investors trading the product include those from the U.K., Australia, Switzerland, Singapore, Cyprus and Seychelles, the Shanghai Futures Exchange, which owns the energy exchange, said in a statement on Monday.

“You can make the trading volume very big, but if not enough foreigners participate in the market, its global influence is limited,” said Shen Meng, director at Chanson & Co., a Beijing-based boutique investment bank.

There are also signs that trading in Shanghai is to a large extent driven by speculators. One indication is that trading volumes regularly far surpass the outstanding positions in the contracts, said Jeff Huang, co-founder of AEX Holdings Ltd., a Hong Kong-based energy-trading firm.

Some analysts say there is less need for hedging in China because of the state’s dominance in the oil industry. “This isn’t a free market so why do I need to hedge?” asked Mr. Huang, pointing to how the nation’s economic planning agency sets prices for oil products.