China Gets Its Own Crude Contract

The world’s top oil importer wants traders to flock to yuan-based futures.

Illustration by 731; Source: Brent Lewin/Bloomberg

Crude oil is flowing eastward as rising demand in Asia outstrips the West’s stagnant appetite. Next year, China wants traders—including oil speculators, refiners, and big state-owned companies that buy and sell futures contracts—to follow a similar path. By the end of 2015, China, the world’s No. 1 oil importer as of April, may start its own crude futures contract.

The idea is to establish a Chinese rival to the world’s two most traded oil contracts: West Texas Intermediate (WTI), housed on the New York Mercantile Exchange, and Brent Crude Futures, owned by ICE Futures Europe in London. The yuan-based contract will trade on the Shanghai International Energy Exchange and will be among the first Chinese commodity contracts available to foreign investors as China promotes global use of its currency.

“Consumption has been shifting east since 2009,” says Gordon Kwan, an analyst at Nomura Holdings in Hong Kong. “China could have more sway in setting benchmark prices with new crude contracts in Shanghai, potentially negatively impacting trading volumes in Brent and WTI over the next 10 years.”

As it becomes more exposed to price swings on global markets, China wants its pricing influence to match its purchasing power. State oil giant China National Petroleum predicts that this year, for the first time, China will import more than 60 percent of the oil it consumes. Over time, the new contract will give China more control over the price of oil it imports, because the value will reflect the supply-and-demand dynamics of China rather than those of the U.S. Midwest or Europe’s North Sea, where stored crude is represented by trading in New York and London.

Before China can exert greater pricing power, traders will have to use its contract. “You need buyers and sellers to come together voluntarily, so it may take a long time,” says Victor Shum, a vice president at IHS Energy, a consulting firm. “Even without their own benchmark, China has had a significant impact on crude futures through their buying.”

Like any commodity derivative, this one will be backed by physical supplies. The Shanghai exchange is planning to use more than 14 million barrels of storage capacity along China’s coast; the oil backing the contract must come directly from the country where it’s produced. No blending will be allowed during shipping or storage; traders won’t get to create custom crude varieties.

“Brent and WTI remain key crude benchmarks,” says Ehsan Ul-Haq, senior analyst at KBC Energy Economics. “The majority of transactions in the oil world are linked to derivatives related to Brent. If Shanghai is able to offer similar trading instruments, we might see some shift.” 

—With Bloomberg News

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