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World's newest oil future still finding its feet

It fluctuates relative to the other benchmarks as market participants are still assessing the appropriate value


THE burden of a quarter century of expectations is weighing on China's oil futures.

The yuan-denominated contract that was launched this week has lofty goals - from providing a benchmark for buyers in the world's biggest oil-consuming region to challenging the dominance of the dollar and encouraging the Chinese currency's use in global trade.

The debut on Monday, which ended years of delays and setbacks since China's first attempt to list the securities in 1993, was given a hand by some of oil's biggest names including Glencore Plc and Trafigura Group. Yet data from the first few days of trading signal that the futures have a ways to go for success.

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Traders were watching for how the contract would be priced relative to other benchmarks, given its unique characteristics. While the futures were expected to be propped up by freight costs for transporting supply to China, the relatively lower quality of oil delivered into the contract signalled it would be dragged down versus European Brent and American West Texas Intermediate.

On Monday, traders brought down the price for September-delivery futures to levels close to Brent for that month. The Shanghai contract traded at a similar level, when adjusted for currency, for the rest of that session and Tuesday.

On Wednesday, though, the Chinese futures broke down sharply and found a new level, lower than Brent and higher than WTI. The fluctuations relative to the other benchmarks signal that market participants are still assessing the appropriate value for the Shanghai contract.

Ideally, the futures would be used to protect against price fluctuations down the line. However, trading in Shanghai has so far been concentrated in the front-month contract more than it is in other markets. The lack of liquidity for further out hurts the ability for industry participants - drillers, refiners and fuel purchasers such as airlines - to hedge future production or consumption.

"One of the concerns for China's oil futures is the extremely high concentration on the nearby futures contracts," said Jian Yang, JP Morgan endowed chair and research director at the JP Morgan Center for Commodities in the University of Colorado Denver. "It could be an indication of the lack of participation by hedgers."

On day two of trading in the Shanghai International Energy Exchange (INE), volumes on the bourse were more than four times as much as levels for Dubai Mercantile Exchange's Oman crude contract. A closer look at open interest, however, points to a less positive picture for the Chinese exchange.

Open interest, a proxy for the amount of hedging activity, in the INE is significantly lower than that of DME. That "points to too much speculative trading on the China oil futures," said Mr Yang. Chinese exchanges are notoriously volatile; take for example its apple futures, where almost one million contracts - the equivalent of US$11 billion worth of the fruit - traded on a single day in March.

That's the kind of frenzy that Chinese regulators want to avoid because it undermines the reliability of the futures as a benchmark. BLOOMBERG