For many decades, the Chinese financial markets remained a tightly controlled affair that, for the most part, locked out foreign and exotic investments. That started to change during the last decade with the country’s capital markets slowly but surely moving into the global investment mainstream. Two years ago, the world’s largest oil importer achieved another milestone after it launched crude oil futures trading that allowed its citizens to participate in the giant market.
While the futures market flourished during its first two years of existence, it did not take long for the proverbial ‘Yang’ to arrive: Chinese investors have suffered horrendous losses after the latest oil market crash that has also devastated their American brethren.
South China Morning Post has reported that Bank of China clients have suffered losses amounting to more than 7 billion yuan (US$1 billion), or 11x bigger than its earlier estimates. The bank had estimated the losses at ~600 million yuan ($85.7 million) during the middle of the week but sharply hiked the estimate after gathering more information from more than 10,000 outlets.
The final tally is subject to change and could still rise as more data comes in.
WTI Collapse
The massive losses stem from the oil price crash on April 21, which sent the price of WTI deep into negative territory. The ill-fated May contracts underpinned Bank of China “Crude Oil Treasure” that it launched in May 2018, leaving thousands of customers counting their losses and demanding that the bank should shoulder some of the pain.
Source: BloombergQuint
Although the bank does not disclose the performance of “Crude Oil Treasure,” the losses could be significantly higher than the latest estimate considering that as many as 60,000 customers had invested in the product as per a report by Chinese publication Caixin.
The crude futures appear to have rapidly gained in popularity, challenging well-established crude futures markets just a few months after their launch.
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In January 2019, investment firm Jordan Knauff and Co (JKC) reported that daily trading volumes for front-month crude futures at the Shanghai International Energy Exchange clocked in at nearly 250 million barrels, ~20% of global trading in similar contracts and pretty close to Brent front-month futures trading volumes. That was less than a year since their launch.
Source: JKC
It could have been a lot worse, though.
The Bank of China doesn’t allow any leverage, which is a good thing because applying leverage would have multiplied those losses. The bank revealed that ~46% of the investors liquidated their positions a day before the contracts were due for settlement while the rest either chose to settle at expiry or roll over their positions.
The result: Investors lost 4.2 billion yuan of their margin and another 5.8 billion yuan that they owe the bank
However, just like its U.S. peer, the USO ETF, which quickly moved its money from near-term to longer-term contacts in a bid to minimize risk, Bank of China has said that it will review the product’s design and risk controls as well as take responsibilities within the legal framework. It also went a notch higher after suspending trading in the product, with China’s other big banks following suit.
However, that might not be enough to prevent further carnage in the future, if the American market is any indication.
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Over the past few months, oil punters have been betting that the coronavirus pandemic would be quickly brought under control, thus allowing crude prices to rebound. However, many retail investors might not be aware that where the USO ETF, the largest crude oil ETF in the country, is one of the easiest instruments to gain exposure to the oil market due to its ample liquidity, it does not accurately track the physical commodity.
Traditionally, the oil ETF is meant to hold long the front-month contract, which gives investors access to the oil spot price. Yet, it has changed its mandate multiple times over the past couple of weeks and now acts more like a hedge fund. While its latest move to shift its money to longer-term dated contracts is likely to make it less volatile, oil prices are not likely to recover in a hurry given that most oil producers would rather sell at low prices than risk even heavier losses through well shut-ins.
The chilling development is that USO long positions have actually tripled since last week’s huge selloff to 200,000, meaning greed is still rampant in the oil market.
Over the past couple of years, Beijing has gone into a heavy deleveraging drive while also trying to instill more risk awareness among millions of its retail investors. The latest rout shows that the lessons have been falling on deaf ears, and these investors are just as likely to follow the heady path being taken by their American peers once the shackles are removed.
By Alex Kimani for Oilprice.com
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