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China Is About to Shake Up the Oil Futures Market

It’s taken a quarter of a century, but China finally has its own oil futures. At 9 a.m. local time on Monday, crude contracts began trading on the Shanghai International Energy Exchange. Futures for September settlement opened at 440 yuan a barrel, up from a reference price of 416 yuan. The world’s biggest oil buyer is offering yuan-denominated futures that foreigners can buy and sell — a first in Chinese commodities. Among the most intriguing questions is whether the traditional benchmarks of Brent crude in London and West Texas Intermediate in New York will face a serious challenger. Here are some of the other key questions.

1. Why is this important for China?

Futures trading would wrest some control over pricing from the main international benchmarks, which are based on dollars. Denominating oil contracts in yuan would promote the use of China’s currency in global trade, one of the country’s key long-term goals. And China would benefit from having a benchmark that reflects the grades of oil that are mostly consumed by local refineries and differ from those underpinning Western contracts.

2. Why now?

The push for oil futures gained impetus in 2017 when China surpassed the U.S. as the world’s biggest crude importer. The Asian nation’s purchases reached a record high in January.

Top Oil Buyer

China surpasses U.S. as world’s biggest crude importer

Sources: China’s General Administration of Customs, U.S. EIA

China Is About to Shake Up the Oil Futures Market

Lower crude prices have played a part as to why not earlier. Chinese oil futures were proposed in 2012 following spikes above $100 a barrel, but prices in 2017 have averaged little more than $50. There’s also concern over volatility. China introduced domestic crude futures in 1993, only to stop a year later because of volatility. In recent years, it repeatedly delayed its new contract amid turmoil in equities and financial markets. Such destabilizing moves have often prompted China’s government to intervene in markets in one way or another.

3. How do oil futures work?

Futures contracts fix prices today for delivery at a later date. Consumers use them to protect against higher prices down the line; speculators use them to bet on where prices are headed. In 2017, oil futures contracts in New York and London outstripped physical trading by a factor of 23. Crude oil is among the most actively traded commodities, with two key benchmarks: West Texas Intermediate, or WTI, which trades on the New York Mercantile Exchange, and Brent crude, which trades on ICE Futures Europe in London.

4. How will Shanghai futures work?

Trading hours will be 9 a.m.-11:30 a.m. and 1:30 p.m.-3 p.m. local time and, at night, 9 p.m.-2:30 a.m. The daily trading band has been set at 5 percent on either side, and 10 percent on its debut day, while margin requirements are at 7 percent. Seven grades will be deliverable, including Dubai crude, Basrah Light and China’s Shengli. The contracts will have 36 delivery months with the first 12 months as rolling contracts. The daily cost to store crude for delivery into the Shanghai exchange is set at 0.2 yuan a barrel, or at least twice the rate elsewhere, in a move seen as deterring excessive price swings.

Contract  Reference Price (yuan per barrel)
SC1809 to SC1903 416
SC1906 to SC2003 388
SC2006 to SC2103 375

Source: INE statement

6. What’s China’s track record in commodities?

Nickel was the last major commodity to be listed there in 2015; within six weeks, trading in Shanghai surpassed benchmark futures on the London Metal Exchange, or LME. In China, speculators play a far greater role, boosting trading volumes but making markets susceptible to volatility. In early 2016, the then-head of the LME said it was possible some Chinese traders did not even know what they were trading as investors piled into everything from steel reinforcement bars to iron ore. Steep price rises relented when China intervened with tighter trading rules, higher fees and shorter trading hours.

7. Will foreigners buy in?

That remains to be seen. Overseas oil producers and traders would need to swallow not just China’s penchant for occasional market interventions but also its capital controls. Restrictions on moving money in and out of the country have been tightened in the past two years after a shock devaluation of the yuan in 2015 prompted a surge in money leaving the mainland. Similar hurdles have kept foreign investors as bit players in China’s giant stock and bond markets. As of March 21, a total of 19 overseas brokers have registered with the Shanghai exchange for dealing the oil futures contract.

8. Could the yuan challenge the dollar’s dominance in oil?