China, the world’s biggest oil buyer, is on the verge of opening a domestic market to trade futures contracts. It’s been planning one for years, only to encounter delays. The Shanghai International Energy Exchange, a unit of Shanghai Futures Exchange, will be known by the acronym INE and will allow Chinese buyers to lock in oil prices and pay in local currency. Also, foreign traders will be allowed to invest — a first for China’s commodities markets — because the exchange is registered in Shanghai’s free trade zone. There are implications for the U.S. dollar’s well-established role as the global currency of the oil market.
1. When will trading begin?
According to the Shanghai-based news portal Jiemian, which cited an unidentified person from a futures company, trading is expected to start Jan. 18. Multiple rounds of testing have been carried out and all listing requirements met. The State Council, China’s cabinet, was said to have given its approval in December, one of the final regulatory hurdles. The push for oil futures gained impetus in 2017 when China surpassed the U.S. as the world’s biggest crude importer.
2. Why is this important for China?
Futures trading would wrest some control over pricing from the main international benchmarks, which are based on dollars. Denominating oil contracts in yuan would promote the use of China’s currency in global trade, one of the country’s key long-term goals. And China would benefit from having a benchmark that reflects the grades of oil that are mostly consumed by local refineries and differ from those underpinning Western contracts.
3. How do oil futures work?
Futures contracts fix prices today for delivery at a later date. Consumers use them to protect against higher prices down the line; speculators use them to bet on where prices are headed. In 2017, oil futures contracts in New York and London outstripped physical trading by a factor of 23. Crude oil is among the most actively traded commodities, with two key benchmarks: West Texas Intermediate, or WTI, which trades on the New York Mercantile Exchange, and Brent crude, which trades on ICE Futures Europe in London.
4. Why didn’t China begin trading futures until now?
Lower crude prices have played a part. Chinese oil futures were proposed in 2012 following spikes above $100 a barrel, but prices in 2017 have averaged little more than $50. There’s also concern over volatility. China introduced domestic crude futures in 1993, only to stop a year later because of volatility. In recent years, it repeatedly delayed its new contract amid turmoil in equities and financial markets. Such destabilizing moves have often prompted China’ government to intervene in markets in one way or another.
5. What’s China’s track record in commodities?
Nickel was the last major commodity to be listed there in 2015; within six weeks, trading in Shanghai surpassed benchmark futures on the London Metal Exchange, or LME. In China, speculators play a far greater role, boosting trading volumes but making markets susceptible to volatility. In early 2016, the then-head of the LME said it was possible some Chinese traders did not even know what they were trading as investors piled into everything from steel reinforcement bars to iron ore. Steep price rises relented when China intervened with tighter trading rules, higher fees and shorter trading hours.
6. Will foreigners buy Chinese oil futures?
That remains to be seen. Overseas oil producers and traders would need to swallow not just China’s penchant for occasional market interventions but also its capital controls. Restrictions on moving money in and out of the country have been tightened in the past two years after a shock devaluation of the yuan in 2015 prompted a surge in money leaving the mainland. Similar hurdles have kept foreign investors as bit players in China’s giant stock and bond markets.
7. Could the yuan challenge the dollar’s dominance in oil?
Not any time soon, since paying for oil in dollars is an entrenched practice, according to some analysts. Shady Shaher, head of macro strategy at Dubai-based lender Emirates NBD PJSC, says it makes sense in the long run to look at transactions in yuan because China is a key market, but it will take years. Bloomberg Gadfly columnist David Fickling argues that China doesn’t have “nearly the influence in the oil market needed to carry out such a coup.” On the other hand, paying in yuan for oil could become part of President Xi Jinping’s "One Belt, One Road" initiative to develop ties across Eurasia, including the Middle East. Chinese participation in Saudi Aramco’s planned initial public offering could help sway Saudi opinion toward accepting yuan, which is used in only about 2 percent of global payments.
The Reference Shelf
- All traders want for Christmas is Chinese oil futures.
- Specifications for the Chinese futures.
- David Millhouse, head of China research and strategy at Forsyth Barr, argues oil futures could pave the way for removing capital controls.
- Gadfly’s David Fickling sees no danger for the petro-dollar.
- A Bloomberg story examines the petro-yuan’s prospects.
- QuickTakes on China’s market meddling and yuan internationalization.
- QuickTakes on the Silk Road and China’s capital controls.