Can China Crude Contract Maintain Momentum?

Copyright © 2021 Energy Intelligence Group

China's first-ever futures crude contract got off to a healthy start on Monday with more than 40 million paper barrels changing hands on the Shanghai International Energy Exchange (INE) (IOD Mar.23'18). Retail and institutional investors were believed to have provided most of the liquidity, but Chinese independent refiners, also known as teapots, and international traders were active in the contract, too. But the big question is whether the contract will be able to maintain a strong level of activity over a long period. Some Chinese sources doubt it. The front-month September contract opened at 440 yuan ($70.10) per barrel and closed at 429.9 yuan ($68.49) per barrel, with most trading fluctuating around 430 yuan ($68.50) per barrel. Shanghai's crude contract trades in standard lots of 1,000 barrels and allows for physical settlement with delivery at specific bonded storage sites. The contract is made up of seven medium-sour crudes prevalent in the local market -- six freely traded Mideast grades and China's Shengli crude. The opening price of 440 yuan/barrel broadly reflects the free-on-board price of Oman crude oil plus transportation and storage costs for a cargo to be delivered to China's bonded sites in September, said a Shanghai-based financial source. He added that a 4% price fluctuation limit illustrates that China wants to keep the daily price movements under control. A total of 40,656 lots of the September contract were traded, equivalent to 40.66 million barrels of crude changing hands for the front-month. Total volume traded on the exchange reached 42,336 lots. Traders Glencore and Trafigura traded the contract, as did at least one teapot, Shandong Wonfull, according to Reuters. Traders with some other international companies with whom International Oil Daily spoke last week, said they were unlikely to rush to trade on Monday, although none dismissed the contract outright. At the very beginning, liquidity should not be a problem because many investors will want to speculate. But it may dwindle after this initial rush, especially if losses are made, said Chinese crude traders. "The domestic stock and futures markets are opaque and some players only consider them as a gambling market," said a central government financial analyst. This differs from the government's goal, which is to have a crude futures contract to help the price discovery process and help enterprises avoid risks, while establishing a regional benchmark to have as an alternative to European Brent and Dubai/Oman. That Beijing wants to have its own oil benchmark is not surprising. China not only took over the US as the largest crude oil importer last year at 8.43 million barrels per day, it has also become the second-largest economy worldwide and is showing growing international aspirations under its leader Xi Jinping. "Once established, China's reference crude prices could act as a regional benchmark for negotiations of spot or term crude oil prices in other markets, such as Japan and South Korea. There is a precedence from the iron ore and coal markets where China's domestic prices and importing patterns are now treated as reference points for the industry," consultancy Wood Mackenzie's research director Sushant Gupta said in a note. "Having Shanghai crude oil futures is just setting up the stage," said a central government energy analyst. If the trading volumes and players are too small, the contract will be useless, he added. While liquidity was never expected to be an issue in the initial stages of the contract, physical delivery of the crude may be a problem. A first test will take place by end-March when companies and investors will choose to settle their positions either financially or through delivery of a physical cargo. Futures contracts are usually only considered successful if they can be underpinned by physical sales. The Shanghai crude futures contract may not increase deliveries of Mideast crude to China, however, especially to teapots, which argue that the delivery process is not convenient for them. Dawn Lee in Beijing, with Maryelle Demongeot, Singapore

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