Shanghai crude futures eat into Western benchmarks as China pushes yuan
SINGAPORE (Reuters) – The launch of China’s first crude futures contract in Shanghai has added a long-awaited Asian benchmark to the global oil sector, challenging the dominance of Western price-markers and threatening ramifications far beyond the energy industry.
Since their launch in March 2018, Shanghai crude futures have stolen market share from the incumbent benchmarks – Europe’s Brent and US West Texas Intermediate (WTI) – which trade oil derivatives worth trillions of dollars every year.
Volumes have also far bypassed other crude futures, such as those that the Dubai Mercantile Exchange (DME) launched in 2007 with the goal of creating a Middle East/Asian price benchmark.
This shift in oil markets could have far-reaching implications, including in foreign exchange markets.
“It’s significant. Given the prominence of China in oil markets, we could see more use of the Shanghai contract,” said Stephen Innes, head of Asia-Pacific trading at futures brokerage OANDA in Singapore.
He said foreign exchange markets were also “taking notice of any yuanification.”
Since launching in late March, front-month volumes in Shanghai crude futures ISCc1 have risen to trade almost 2.8 million lots of 1,000 barrels in July.
This gave the contract a market share for July of 14.4 percent, compared with 28.9 percent for Brent LCOc1 and 56.7 percent for WTI CLc1 crude futures.
“Shanghai crude has good liquidity due to its high volatility and its correlation with international oil futures. It has become a good investment for speculators,” said Zhang Huiyao, Deputy General Manager for crude oil trading at Huatai Futures in Guangzhou.
Despite this early success, operator Shanghai International Energy Exchange is playing it cool.
“China’s crude oil futures remain … behind the mature contracts in Europe and the U.S.,” President Jiang Yan told Chinese media this month.
“For the contract to have greater impact, it requires … greater participation by foreign companies,” he said.
Zhang Huiyao of Huatai Futures said more industrial players and pure trading companies would also help.
“We are hoping the exchange will create more derivatives contracts linked to the current crude oil futures to engage more diverse investors,” she said.
Commodity exchanges often build futures volumes by introducing related contracts, which could include buy/sell options, forward contract time spreads or, in the case of a crude contract, derivatives for refined fuel products.
Given China’s status as the world’s biggest oil importer, some analysts say the rise of Shanghai crude futures as a benchmark was inevitable.
Yet there has been a more immediate reason for its fast rise: U.S. sanctions against Iran.
Washington re-imposed sanctions on Tehran in May, including its financial sector and transactions in the U.S. dollar. From November, the sanctions will also target Iranian oil exports, and Washington has put pressure on companies and governments around the globe to fall in line.
As Iran’s biggest customer and amid its trade dispute with Washington, Beijing is expected to ignore US demands.
China is already shifting some of its crude futures trading activity away from the dollar and into its own yuan.
“I’m convinced China’s strategy on the trade war is it will continue to purchase crude from Iran in yuan, hedging (in) Shanghai,” Innes said, eliminating the currency risk of buying oil in the U.S. dollar.
Given Russia’s own disputes with Washington, Innes said it could also be interested in selling oil to China in the yuan.
END OF A DUOPOLY?
Shanghai crude futures could eventually remake global oil markets.
Beyond an active take-up from domestic retail traders, China’s large oil firms have moved some futures positions out of Brent and into Shanghai crude, said Barry White, senior vice president for derivatives sales at U.S. financial services firm INTL FCStone.
Chinese oil refiners find the medium to sour Middle East crude underlying Shanghai futures “more in line with their imports and usage” than Brent, which is priced off North Sea crude grades that tend to be lighter in quality, White said.
The first front-month contract since the Shanghai oil futures were launched is due for delivery in September, with Chinese oil-trading majors like Unipec , China National Petroleum Corp (CNPC) [CNPET.UL] and Zhenhua Oil accounting for most of the volume.
CNPC declined to comment, while Unipec and Zhenhua Oil did not immediately respond to queries.
Western commodity merchants and banks have also been doing test trades in Shanghai crude futures, brokers and company sources said, and are planning to start playing a bigger role.
While other futures like DME’s Oman crude 1OQc1 have had some success as a benchmark for physical oil prices, their take-up by the financial industry has been limited.
China’s new benchmark could change this, potentially breaking the Brent-WTI financial duopoly that has dominated oil trading for decades, requiring international traders to get used to dealing some crude futures in yuan.
“The internationalisation of the yuan will continue to pick up the pace as mainland markets become more accessible and transparent, and the Shanghai oil contract is an excellent start to that process,” said OANDA’s Innes.