China eyes global oil futures prize — Clyde Russell
LAUNCESTON (Australia), July 22 — Breaking the global dominance of West Texas Intermediate and Brent in the crude futures market is no easy task, but the Chinese are now lining up for a shot.
The Shanghai Futures Exchange (SHFE) is planning to start up an oil futures market within months and has made reassuring noises that foreigners will be allowed to participate fully.
No doubt the Chinese will be hoping to emulate the success of their other commodity futures markets, which accounted for more than half the total volume of commodity derivatives traded worldwide in 2010.
However, the existing markets are largely focused on agriculture and mainly used by domestic players.
Taking on the global crude giants is another matter altogether, and you have to go no further than Singapore and Dubai to see the extent of the challenge.
The Singapore Mercantile Exchange has had cash-settled WTI and Brent in euros futures for the past few years, but they failed to take off and are now effectively dead, with no open interest and no trading.
The Dubai Mercantile Exchange, launched in 2007, has had more success with its futures contract, but even its current open interest for the front-month, at 7,081 lots, is piddling compared to the more than 287,000 for New York-traded WTI and 247,000 for London’s Brent.
It’s not that the Dubai contract is badly designed: in fact in many ways it’s a far superior marker than either WTI or Brent as it is based on a crude that has substantially more volume available than Brent and it doesn’t suffer from a land-locked location like WTI’s delivery point of Cushing, Oklahoma.
The Dubai contract is also way more relevant for Asia as it is based on a heavier, sour crude, a type which is much more commonly used in the region’s refineries than light sweets such as Brent and WTI.
But the fact that it hasn’t gained more traction in the market shows the depth of the challenge facing the SHFE.
While the SHFE hasn’t released full details of its planned crude contracts, what is known so far is encouraging.
The aim is make the Shanghai contract the benchmark for Asian oil pricing, attracting producers, refiners and hedgers such as companies and traders.
This all makes perfect sense when you consider that China is the world’s second-largest crude importer, with the monthly total topping six million barrels a day for the first time in May.
It will be based on a medium, sour crude and will be priced in either dollars or yuan, with delivery into bonded storage in China.
The bourse is also trying to get government approval for foreigners to actively participate in both converting currency freely and trading the contracts.
If the SHFE does not succeed in getting that approval, it may as well give up and resign itself to the likelihood that any futures based solely on domestic trading won’t become a regional benchmark.
Assuming free participation for foreigners — and this is a fairly big assumption as it would be a first for China — then the contract still has numerous challenges to overcome.
A deliverable contract is good as it serves to keep all parties honest in their dealings.
But the idea of delivery at the consuming point rather than the producing point is interesting, as it raises the question whether the freight and insurance costs involved in getting the oil there will be a factor in the contracts’ prices.
Also, how much free storage will be available for hire, and at what cost?
To attract the really big players in the market, there will have to be enough storage so that prices can’t be manipulated by a lack of physical oil to back delivery on contracts.
Assuming the SHFE can get the contract design spot on, and allow unfettered access to foreigners, they have a shot at succeeding, especially since market participants want to be part of the China story.
The world is crying out for better benchmarks than Brent and WTI.
Singapore and Dubai, which like Shanghai have ambitions to become global financial centres like London and New York, have had a shot at the title and come up short.
It’s now Shanghai’s turn. — Reuters
* This is the personal opinion of the writer or publication and does not necessarily represent the views of The Malaysian Insider.