China crude futures becomes new force

World
Europe

After years of preparation, China is getting closer to launching its own crude oil futures.

The Shanghai International Energy Exchange has finished four rounds of mock trading exercises, and investors from China and other economies will soon witness the country's own crude oil futures market.

Currently, international oil prices are set by benchmarks such as the Brent in the UK and the West Texas Intermediate (WTI) in the US.

That could change when China — the world's second largest oil consumer which imported 381 million tons of crude oil in 2016 — launches its own crude oil futures.

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The China-led benchmark “will certainly increase the liquidity of oil futures market as well as the efficiency of the oil market,” said Wang Cong, a finance professor at the China Europe International Business School.

Chinese investors have been waiting for the crude futures for quite some time, and experts say the time to roll out crude oil futures is ripe in 2017, as domestic capital markets have matured over the past years thanks to reforms.

"In the past two years, China has launched several reforms in terms of allowing non-state-owned enterprises to participate the import of crude oil," said Wang. "So now we have more players in the physical oil sector, which will certainly improve the liquidity of the crude oil futures market."

China now has a more open capital market for foreign investors. With the launch of two stock connects and one bond connect program, international investors are now more receptive to RMB-denominated assets.

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However, analysts say that if China wants to let its own crude futures carry weight in global pricing, launching the futures is just the first step.

"So if the goal of this contract is to become a part of the global price discovery, it means you have to let the globe come in and trade it as well," noted David Nealis who heads a finance firm in Shanghai, and is now in Chicago talking to a consortium of US investors about the coming Chinese crude futures.

Analysts say crude oil futures would be attractive to China's massive number of retail investors as well, compared to other commodity items.

"Oil is kind of common product, it's not like metal things or agricultural goods," said Tang Ren, quantitative department manager at Galaxy Futures. "It's not like you're not in this business and you have no idea about how the pricing is going on about metal or about agriculture."

But crude prices are general affected by policies and major geo-political events — things that get on global headlines. Experts say while crude futures might be easier to analyze, it is also riskier to trade compared with equity.

“When you trade oil futures you have to use leverage, which will tend to amplify your return,” Wang stressed.