The billion-yuan question facing China’s crude futures exchange
China, the world’s second-largest economy and largest crude oil importer, launched its own crude oil futures exchange — the Shanghai International Energy Exchange (INE) — in early 2018 with a few freely traded medium sour crude grades priced in the Chinese yuan.
China is seeking to establish its own oil benchmark that could act as a regional one for spot or term crude market pricing with other Asian refiners. And in order to support its currency’s internationalization, China seeks to trade yuan-denominated crude contracts in the non-US dollar exchange to gradually take a leading role in benchmarking crude oil in Asia and worldwide.
Will the US-China trade war affect the INE’s future? This has been an ongoing question since the exchange’s launch shortly before the escalation of the trade dispute between the world’s two largest economies. The trade war might impede the INE as the first non-dollar oil index in the Asia-Pacific region.
China is trying to allow oil exporters to exceed dollar-denominated standards by trading in the yuan, taking advantage of the absence of an Asia-Pacific benchmark for pricing at Asian refineries, since most of the imported oil remains linked to the Dubai and Oman crude indexes in the dollar.
The INE is trying to be independent in enabling some oil-exporting countries to avoid dealing with the dollar. But this attempt cannot change the rules of the international oil game and dollar transactions. This is primarily subject to the contracts drafted by oil-producing countries. One of the INE’s tools to succeed might be allowing Iran to overcome US economic sanctions by trading oil in the yuan.
China is trying to allow oil exporters to exceed dollar-denominated standards by trading in the yuan.
Even though the INE has succeeded in attracting some oil producers that prefer to avoid using the dollar in their dealings, the rest of the producers are unwilling to accept yuan payments against oil sales to China, especially as this will be subject to the volatility of the country’s economy and its unstable banking system.
Therefore, the INE will not affect the dollar exchange rate, and will not create a competitive benchmark for oil markets, unless supported by oil producers. Hence it is unlikely to become one of the standard platforms for oil traded globally. The trade war will limit the INE’s activities, but the exchange might help China’s independent refineries, which import around 2 million barrels per day of crude oil from the spot market.
Physical crude delivery is often seen as the mark of a successful crude futures exchange, reconciling futures contracts and physical prices. How large the volumes traded are, and how smoothly the delivery process unfolds, will be keenly watched as they offer clues as to whether China can realize its oil pricing ambitions as a regional benchmark.
The delivery process, as an important link between futures and spot cargoes (physical delivery), should help realize the convergence of futures and spot prices. The INE should provide a reliable reference for forthcoming contracts to keep liquidity in order to attract more market participants.
Successful delivery should indicate if INE futures could be accepted among market participants. The exchange is still challenged by delivered volumes, which have not yet emerged in future contracts delivery. The INE should provide another option to measure the value of oil in physical crude markets to change speculators’ patterns without separating futures prices from physical oil markets.
- Faisal Mrza is an energy and oil marketing adviser. He was formerly with OPEC and Saudi Aramco. Twitter: @faisalmrza