Kemp: China's Crude Oil Futures Contract Should Confound The Skeptics



Reuters

(John Kemp is a Reuters market analyst. The views expressed are his own)

LONDON, March 29 (Reuters) - China’s new crude oil futures contract, which began trading this week, has a good chance of confounding the doubters and becoming a regional benchmark where other contracts have failed.

The history of futures and options trading is littered with new contracts launched amid great fanfare but which subsequently failed to develop sufficient liquidity and have been discontinued or faded into irrelevance.

But the new crude futures contract launched on the Shanghai International Energy Exchange comes after years of meticulous preparation and has many of the ingredients needed to be successful.

Three elements determine the success or failure of a new futures contract, according to an extensive literature review prepared for the Shanghai Futures Exchange three years ago.

The contract must fulfil a commercial need for hedging. It must succeed in attracting a pool of speculators. And public policy must not be too adverse (“Why some futures contracts succeed and others fail”, Till, 2014).

China’s new oil futures contract clearly meets the first two criteria and has a fair chance of succeeding on the third as well.

Meeting A Hedging Need

China has already overtaken the United States to become the world's largest crude importer, so there is a clear need to hedge the resulting price risks.

The need for a new contract and its basic features were showcased two years ago in a presentation by China’s leading crude importer (“Review of current and potential Asian oil benchmarks”, Unipec, 2016).

China’s refiners import mostly medium and heavy sour crudes, which trade at a substantial discount to lighter and sweeter oils.

The two main existing benchmarks, Brent and U.S. light sweet crude, also known as WTI, are based on light low-sulphur crude oils.

In contrast, the new Shanghai futures contract is based on a basket of medium and heavy crudes from the Middle East and China itself with a significantly higher sulphur content.

The new futures contract approximates the sort of crudes that China is importing much more closely than Brent or WTI.

Foreign crudes deliverable against the contract include oils from the United Arab Emirates, Oman and Iraq, which all trade freely.


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