September 4, 2018 / 3:39 AM / a year ago

Breakingviews - Shanghai's early market win threatens oil duopoly

People attend the launch ceremony of Shanghai crude oil futures at the Shanghai International Energy Exchange (INE) in Shanghai, China March 26, 2018. China Daily via REUTERS

SINGAPORE (Reuters Breakingviews) - Shanghai’s early success with its new oil market is beginning to threaten the duopoly of Brent and WTI. In four months, the yuan-denominated crude futures contract has built a 7 percent share of global crude turnover. Dealing in a state-managed currency remains an issue for investors, and Western traders have yet to really weigh in. But Beijing is on the way to building a credible benchmark.

    China, which has overtaken the United States to become the world’s top oil importer, wants more pricing clout in a market worth trillions of dollars. The government also wants to see more transactions conducted in yuan, and to help its companies hedge more. The crude futures contract on the Shanghai International Energy Exchange, launched in March, ticks all those boxes.

    Benchmarks are hard to establish in a market dominated by two dollar heavyweights: a Russian attempt has stagnated. But a few months in, the Shanghai contract has garnered unanticipated clout. Volumes and open interest, which measures market activity, now rival the comparable Dubai Mercantile Exchange contract. In July, Shanghai took a roughly 14 percent share of the market as measured by front-month volumes – trade in the contract closest to delivery. The Brent benchmark took two decades to hit the same level.

    China cleared an early operational hurdle cleanly too, with the settlement of its first contract for September - physical players had fretted about potential delivery hiccups.

    External factors, including oil price volatility, have contributed to Shanghai’s success. U.S. sanctions may have also inadvertently supported trade: China is Iran’s biggest customer, and while Iranian oil is not deliverable through the Shanghai exchange, there are workarounds. Russia may also climb aboard.

There is work to be done. Almost all of the Shanghai trade is concentrated in the most active front month, whereas WTI and Brent see volume spread across the curve - better for managing risk. In response, the INE is considering introducing market makers to fuel activity in longer-dated contracts, and has cut fees.

The market remains dominated by Chinese state players; Western traders like Glencore, Trafigura and Vitol, whose participation is critical for global credibility, are largely on the sidelines. Their caution is tied to Beijing’s currency and capital account restrictions, which are unlikely to go away soon. Other fixes, though, will help Shanghai build on a good start.


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