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Back to the futures for Chinese crude

The successful opening of a long-awaited yuan-denominated oil futures contract bodes well for the country’s aim to create a regional benchmark

After nearly six years of speculation, rumours, and declared intentions, the Shanghai International Energy Exchange (INE) finally launched China's first-ever oil futures contract on 26 March.

Liquidity was strong on launch day, with 40,656 contracts worth around ¥17.6bn ($2.8bn) filtering through the system, according to the exchange's figures. The most active September contract settled at ¥429.9 a barrel, after fluctuating between ¥426.3/b and ¥447.1/b during the trading session.

Before the INE opening, domestic and international market participants—both speculative investors and oil companies looking to mitigate risks taken in oil markets—might have been forgiven for scepticism. The exchange's launch had been delayed amid a personnel merry-go-round at its top echelons, that was in step with the country's wider economic deliberations.

Market participants not involved in China's oil markets also debated the need for yet another attempt at creating a global benchmark, given the status of Brent and West Texas Intermediate (WTI) as the widely-accepted benchmarks for oil transactions across the globe.

Critics said the Chinese political hierarchy would obstruct the potential success of the contract. In the past, when a commodity futures contract is considered "overheated", Beijing has stepped in to slow markets and isolate potential sources of volatility which pose a threat to the wider economy. That, and the country's decision to overhaul market regulation based on assessments of wider national markets, have traditionally caused uncertainty over any Chinese contract. These all remain valid concerns.

But the months that led up to the contract's eventual opening saw timely changes for the INE. In 2017, the government announced plans to open up its financial system to international market participants, with a range of reforms in the way institutions and individuals can access and trade yuan. The domestic speculative market hit new heights in trading activity, growing within an assumedly acceptable rate to government officials to refrain from intervening.

International aspirations

China also became the world's biggest crude importer in 2017, thanks to surging domestic demand. Should the contract attract enough liquidity over a sustained period of time, it could help China gain pricing power in oil markets, while further internationalising the yuan.

The INE's launch comes after changes in the past two years to the composites of the Brent and WTI contracts that some saw as positive modernising steps, but which others said do not go far enough to ensure their future relevancy.

While it has taken a long time to refine the contract, the INE has built a robust trading infrastructure around it. There are limits on the number of cancelled orders to eradicate spoofing—the act of placing then cancelling a trade in an attempt to force the price in a certain direction. Trading is carried out during three established periods per day, and there will be longer delays during national holidays. The rationale behind these decisions is to both concentrate liquidity, and increase transparency in the nascent market.

These measures help paint a picture of a robust, liquid, and attractive contract, but international market participants will no doubt have reservations. While the efficacy and liquidity of the contract could no doubt be supported by China's massive domestic speculative market, its status as an international—if not regional—oil benchmark will be based on its acceptance on the global playing field. Wider political and economic affairs have become strained of late, with the US imposing tariffs on around $50bn worth of Chinese goods and Beijing threatening to retaliate in kind.

While China's long-awaited crude futures contract has started strongly, it requires patient domestic custodianship by the INE while remaining free from inference or price manipulation. It also needs the free support of high-profile market players, free from political interference, in order to become established, and take a foothold in international energy markets.

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