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China Hopes To Setup New Oil Futures Contract By End Of Year

China Hopes To Setup New Oil Futures Contract By End Of Year

Recognizing its position as the world’s largest oil importer, China is moving to create a futures contract for crude.

The new contract would be listed on the Shanghai International Energy Exchange, known as INE, and trading could begin by the end of the year. The benchmark will not rival WTI or Brent just yet, but China is an increasingly important market for crude oil, as well as other commodities. According to the Wall Street Journal, investors in China are looking for new investment vehicles to get in on commodity markets, and the new Asian benchmark would provide that. Related: Three Eagle Ford Stocks Worth A Look

There would be some unique hurdles that could hold back the new Shanghai oil benchmark, the largest of which is the fact that it will be priced in the local currency, the yuan. That reflects the interest in having a marker that is available to Chinese investors. Still, China wants it to be a global benchmark, and has promised to keep it open to foreign investors. That would provide the fledgling market with liquidity.

But the problem is that oil is traded in US dollars around the entire world. Creating a new benchmark priced in a different currency imposes extra risks on investors. Not only is oil historically volatile, which is something commodity traders always have to worry about, but trading in yuan will add currency risk on top of commodity risk. Related: Cold Shoulder For Russia Could Hint At OPEC Decision June 5th

Another problem is that the new marker will use 100 barrels of oil in a given futures contract, instead of the international norm of 1,000 barrels per contract.

China does not have an entirely open market and has restrictions on the movement of capital. Yet over time, ever so gradually, it has relaxed controls. The interest in creating a new oil futures contract demonstrates another step forward in a long campaign to open up its economy. Related: Forget the Noise: Oil Prices Won’t Crash Again

The new contract will also better reflect market conditions in Asia, rather than elsewhere in the world. WTI is a benchmark for US oil market conditions, while Asia tends to depend heavily on the Brent marker based in the North Sea. But specific developments that occur in the North Sea (say, a supply outage) could lead to a spike in Brent prices, which would then affect pricing in Asia regardless of circumstances there. China hopes to mitigate this risk by setting up the local futures contract.

By Charles Kennedy of Oilprice.com

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