China launches new oil futures contract in yuan

With a demand of almost 9 million barrels a day, last year the People’s Republic of China became the biggest oil importer in the world, surpassing the United States. Since 26 March a future connected with the price of crude oil, denominated in yuan rather than dollars, has been trading on the Shanghai futures exchange. A new development that surprises more for its timing than anything else, but there are strong reasons behind China’s decision to wait until now to launch the new contracts in yuan. This is what China has done and what its goals are in the sphere of commodities.

A reasoned delay

Beijing has overtaken Washington thanks to the shale oil boom in the US. The increase in production of this raw material in the US has reduced US imports to an average of 7.75 million barrels a day. For black gold producers like Russia, Iran and Saudi Arabia, the greatest demand is now coming from China, which until now had avoided introducing its own crude oil future contract for two main reasons: its volatility and low prices.

Characteristics

The crude oil futures contracts in yuan include seven different grades of underlying crude: Oman and Dubai crude, the light Iraqi Bashra crude and Chinese Shengli, Upper Zakum from the Arab Emirates, Qatari Marine and Yemeni Masila, but no oil from Saudi Arabia, Russia or the US. They also have different traits that make them an instrument dedicated mainly to local investors, even if officially they can also be traded by foreign brokers. In particular: the trading hours are based on the Chinese market model with breaks during the day (morning session: from 9 until 11.30 a.m. Afternoon session: from 1.30 until 3 p.m. Night session: from 9 p.m. to 2.30 a.m.); the currency of denomination in yuan; the heavy margins; the liquidity/depth of the market, still low, accompanied by a low number of expiry dates offered (first 12 consecutive months from September 2018 followed by 8 consecutive quarters); the far-from-straightforward trading admission criteria. Characteristics, analysts believe, that will keep it behind the Brent and Wti duopoly for some time yet.

The objective

By launching a crude oil future in yuan in Shanghai, Beijing’s goal is quite clear: to threaten the US control of the commodity market, today largely denominated in US dollars. How can it achieve this goal? By creating a valid benchmark for Asia that is able to compete with Brent in Europe and West Texas Intermediate in the US.

In the long term, the new contract could even support the rise of the Chinese currency as a genuine alternative to the dollar. That’s not all: by staking its claim to becoming a leading reference market, Beijing also hopes to acquire more favourable import conditions. In short, the ambition of the economic system with the highest net demand for petroleum products in the world is to enter the arena in which the mechanisms of the supply and pricing of fuels are negotiated.

Critical issues

The new Chinese future is not, however, devoid of risk. The first of these regards its biggest novelty: the currency. The yuan is not completely convertible and its fluctuation is not completely entrusted to the market. It is the People’s Bank of China that updates the exchange rates between the yuan and the biggest international currencies on a daily basis. For this reason a secondary off-shore exchange rate was launched for those that purchase from abroad with a ceiling of 4% on daily fluctuations as a measure to avoid possible speculative attacks. Now the market will decide whether the dollar’s era of dominance is soon to become a thing of the past.