After a wait of about a quarter of a century, the world’s biggest oil buyer is finally getting its own crude-futures contract.
In a challenge to the world’s dollar-denominated oil benchmarks Brent and West Texas Intermediate, China will list local-currency crude futures in Shanghai on March 26, according to the nation’s securities regulator. The start of trading, open to foreigners, will mark the end of years of delays and setbacks since China’s first attempt at a domestic contract in 1993.
If the futures are embraced by overseas investors and become a benchmark for global oil transactions, China’s hoping the yuan could threaten the dominance of the greenback in international trade. But skeptics say that will never happen as long as the currency is controlled by the central government, and while international traders may agree to settle contracts converted into yuan, they’ll continue to price the oil in dollars.
“This is a first small step toward China becoming a more active price-setter in oil but for Shanghai to come anything close to a global benchmark, it will take years,” Michal Meidan, an analyst at industry consultant Energy Aspects Ltd., said before the announcement. “While this gives another impetus to liberalise the yuan, there are bigger obstacles related to volatility and capital outflows that will dictate the pace.”
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China’s trying where others, including Russia, have stumbled. But while international investors may prove circumspect, there’s little doubt the Chinese will embrace their own oil futures enthusiastically. Trading in contracts across the nation’s three commodity exchanges has exploded in recent years, as speculators buy and sell everything from iron ore to soybeans with such intensity that regulators have repeatedly stepped in to quell fears of a bubble.
Soaring volumes dwarf open interest in those assets, raising concern about excessive speculation and their reliability as a benchmark.
Commodities Pricing
Oil futures are part of a strategy to encourage the use of the yuan in trade and expand China’s clout in raw-materials pricing. The pace of development has been glacial. The government introduced a domestic crude contract in 1993, only to stop a year later. In recent years, it repeatedly delayed the plan amid turmoil in equities, financial market volatility and the crude price crash.
China surpassed the U.S. as the world’s biggest oil importer last year, buying about 8.43 million barrels a day to feed demand from government-run as well as independent refiners. The nation has also been hoarding million of barrels for its Strategic Petroleum Reserve. Rather than buying how much ever crude they want, private companies have to adhere to government-issues quotas for their purchases. And this year suchallocations expanded.
The move toward creating a so-called “petro-yuan” will be a “huge story,” Adam Levinson, the founder and chief investment officer of Graticule Asset Management Asia, said in October. Besides serving as a hedging tool for Chinese companies, the contract will aid the broader government agenda of increasing the use of the yuan in trade settlement, he said.
China has been pushing the international use of the yuan since a decade ago, setting up clearing banks and currency swaps around the world, and has built offshore trading hubs from Hong Kong to London. The International Monetary Fund decided in 2015 to include it in its special drawing rights basket, joining the dollar, euro, pound and yen. Still, it’s not fully convertible.
“The operational side of things remains unclear, given that the currency is still not freely convertible,” said Energy Aspects’ Meidan. “Developments in the Shanghai Futures Exchange in this respect will be dictated by the government’s broader policy on currency, not the other way round.”
A potential investment in an initial public offering by the world’s biggest crude exporter, Saudi Arabian Oil Co., could help the initiative. China Investment Corp., the nation’s sovereign wealth fund, could take part in the planned IPO, people with knowledge of the matter said in March last year. Two of the Asian country’s state oil companies also may buy shares in the firm known as Aramco, according to their senior executives.
Trading Houses
International commodity trading houses such as Mercuria Energy Group Ltd., Vitol Group and Glencore Plc could potentially use the futures for trading arbitrage and hedging, according to Chen Tong, an oil analyst with Tianjin-based First Futures Co. The contract may also be attractive for financial institutions such as investment banks and funds, he said before the announcement.
“First, the trading volumes need to get active, then domestic refiners need to end up using it as benchmarks for trading, and eventually it could reach its aim of becoming a pricing benchmark for Asia,” Chen said. “For yuan internationalization, of course, it fits the mission, with more and more oil-producing countries moving away from dollar-linked oil contracts.”
