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By Clyde Russell
LAUNCESTON, Australia Jan 23 The quiet demise
of China's plans to launch a new crude oil futures contract
shows the innate conflict of wanting the financial clout that
comes with being the world's biggest commodity buyer, but also
seeking to control the market.
It has been a long-standing ambition for a new global oil
price benchmark to be established in Shanghai, a move that would
reflect China's rise to vie with the United States as the
world's largest importer of the fuel.
But it would seem that the plans are on hold, at least for
now, with the Shanghai International Energy Exchange (INE)
failing to garner sufficient support from market players for a
new benchmark, Reuters reported on Jan. 20, citing five sources
with knowledge of the matter.
The main issues were concerns by international players about
trading in yuan, given issues surrounding convertibility back to
dollars, and also the risks associated with regulation in China.
The authorities in Beijing have established a track record
of clamping down on commodity trading when they feel the market
pricing is driven by speculation and has become divorced from
supply and demand fundamentals.
On several occasions last year, the authorities took steps
to crack down on trading in then hot commodities such as iron
ore, steel and coal.
While these measures did have some success in cooling
markets, they are generally anathema to international traders,
who prefer to accept the risk of rapid reversals in order to
enjoy the benefits of strong rallies.
It's likely that while the INE could design a crude futures
contract that would on paper tick all the right boxes, it would
battle to overcome the trust deficit that exists between the
global financial community and China.
What international banks and trading houses will want to see
before they throw their weight behind a new futures contract is
evidence that Beijing won't interfere in the market to achieve
outcomes in line with its policy goals.
It will be hard, but not impossible, to guarantee this, with
the most plausible solution being the establishment of some sort
of free trade zone in which the futures contract could be
But getting everybody to agree on the exact mechanisms of
how this would work will be extremely challenging, and time
Overall, what this means is that Asia, the world's top
crude-importing region, will have to soldier on with its current
imperfect ways of pricing crude oil.
ASIA STILL WAITING
The global benchmark futures contract on Brent crude,
operated by Intercontinental Exchange and CME Group's New York
Mercantile Exchange, don't really reflect the reality of crude
trading in Asia.
The most obvious problem is that Brent is a light crude oil,
while most of Asia's physical trade is in heavier grade crudes,
such as those pumped by Middle East producers.
The Dubai Mercantile Exchange (DME) operates a
well-respected contract on Oman crude, but despite offering a
viable hedging tool and physical trading platform, the contract
has struggled to become a leading benchmark.
For example, the daily volume of contracts on the DME
averaged 8,762 lots in 2016, while Brent futures on ICE averaged
about 57,600 last year.
For many oil traders in Asia the main price discovery
mechanism is the Platts trading window, known as the Market on
This system allows traders to buy and sell various grades of
Middle East crudes through the Platts system.
While the various participants can see buyers and sellers,
the data isn't available to the wider market, meaning it lacks
the transparency of a deliverable futures contract and is of
little use to non-physical crude traders.
The Platts window is also vulnerable to undue influence by
major traders, given the limited number of cargoes each month
and the ability of some major players to buy most of what is
While Platts has worked to address the issues by adding more
grades of crude, the current system is probably a long way short
of ideal, and doesn't reflect the importance of Asia in global
There is little doubt that the current ways of pricing crude
belong to an era where the United States and Europe were the
predominant buyers, and physical traders were a cosy circle of
insiders who preferred to operate largely without regulation and
It's natural that China wants to flex its muscles in global
commodity trade, and it also makes sense for Asia to have a
crude oil benchmark directly related to the types of crude it
It's also logical that this contract should be based in
China, but in order to achieve success it will have to enjoy the
confidence of all participants.
It will have to be liquid, convertible and stable from a
The INE's proposed contract can't really fulfil these
requirements currently, and it may be some time before it can.
(Editing by Joseph Radford)