By Bian Gangyue, Zhang Fuqin, CPPEI
On March 26, 2018, China Crude Oil Futures was officially listed in Shanghai International Energy Exchange, a subsidiary of Shanghai Futures Exchange. Through nearly one year's operation, the market is now running smoothly, and the market participants are increasing steadily.
Operation characteristics after listing
1. The market scale expands steadily
From March 26 to August 31, 2018, the cumulative bilateral volume of Shanghai crude oil futures was 17.965 million lots; the first delivery was completed on September 7, 2018, and the delivery of crude oil futures SC1809 contract was successfully completed, with a total delivery volume of 601 000 barrels, a delivery amount of RMB293 million (unilateral), and a settlement price of RMB488.2/barrel, up 10.95% from the opening price of RMB440.0/barrel on March 26. As of September 7, 2018, unilateral statistics showed that the total trading volume of crude oil futures reached 11.8082 million lots with the turnover of RMB5.77 trillion; the daily trading volume averaged 102 700 lots with a turnover of RMB50.166 billion.
2. Market price discovery function appears
From the perspective of market prices, Shanghai crude oil futures prices are slightly higher than Brent crude, within a reasonable range, having good correlation with Brent, WTI, Oman and other major international markets, and reflecting its relatively independent market trend and the supply-demand relationship between China and the Asia Pacific region.
While Shanghai crude oil futures prices are linked to the prices of international crude oil futures contracts such as Brent and WTI, it presents two stages of the price trends.
In the first stage, from April to June of 2018, the main contract prices of Shanghai crude oil futures were at a stage of exploring reasonable price spread and were lower than the international benchmark prices such as Brent and WTI. The data shows that Shanghai crude oil futures prices were basically in sync with the spot prices of Oman crude oil, with a correlation of 93%, and the correlation with Brent was 90%.
On May 23, 2018, Brent crude prices rose to US$79.8/barrel after the United States announced its withdrawal from the Iranian nuclear agreement. On the same day, Shanghai crude oil futures also rose to a high of RMB488.1/barrel. On May 25, OPEC and Russia studied the possibility of the suspension of the production curtailment agreement, and oil prices fell rapidly. On June 4, Brent crude prices fell to US$75.29/barrel, a decline of 6%, and Shanghai crude oil futures fell by 4% to RMB470.6/barrel. On June 29, Brent rose to US$79.44/barrel, 6% higher than June 4, and Shanghai crude oil futures rose to the highest level of RMB494.6/barrel, 5% higher than June 4, as the market was worried that the US sanctions on Iran would reduce the crude oil supply.
In the second stage, after July 2018, due to the combined effects of RMB depreciation and market supply-demand, Shanghai crude oil futures prices deviated from the trend of Brent and Oman prices; after mid-August, Shanghai crude oil futures prices trend became consistent with Oman crude prices, as shown in Figure 1.
Figure 1 Trends of three crude futures prices from March 16 to August 29, 2018
During July to August 2018, due to the sharp depreciation of the RMB against the US dollar, the price of Shanghai crude oil futures denominated in RMB was once higher than the price of Brent crude oil, straightening out the price difference between Shanghai crude oil and Oman crude oil. In particular, the prices of Shanghai crude oil futures, denominated in RMB, rose by nearly 6% in July, a record high.
3. With international characteristics
Up to now, there have been more than 30 000 accounts in Shanghai crude oil futures, mainly domestic and foreign entities and investors, including oil-related enterprises, oil-related trading companies, financial institutions and fund companies. The participation of overseas customers is also deepening. The proportion of international traders' positions has increased from 5% in the first two months after listing to about 15% at present. There are already state-owned oil companies having signed long-term supply contracts with multinational oil companies with Shanghai crude oil futures prices, settled in Renminbi, as the benchmark price.
4. Strong influence on domestic crude oil prices
China is highly dependent on imported crude oil, with the import dependence of more than 65%. Based on the annual net import volume of 396 million tons in 2017, the daily net import volume of crude oil averaged 1.08 million tons. The trading scale of the crude oil futures market is 10 times larger than the net import scale of the real market. Therefore, the Shanghai crude oil futures market has a strong influence on the domestic crude oil price.
5. Providing benchmark crude oil prices for domestic refined oil pricing
China’s refined oil benchmark pricing is based on the weighted average of Brent, Dubai and Minas crude oil prices, together with domestic import tariffs, refining costs, circulation costs and appropriate profits. Through data comparison, it is found that, from March 26 to August 31, 2018, the proportion of Shanghai crude oil futures prices to domestic refined oil wholesale prices, compared with the proportion of Brent crude oil prices in the same period (converted at the exchange rate of RMB to US dollar on the same day), is basically stable. Since the listing of Shanghai crude oil futures, the wholesale prices of refined oil fluctuated at RMB6 795-8 015 /t, with the Brent prices accounting for 46%, and the Shanghai crude oil futures 45%. According to studies, the average proportion of Shanghai crude oil futures is roughly the same as that of Brent, reflecting that Shanghai crude oil futures prices can provide a benchmark crude oil prices for scientifically determining the pricing mechanism of domestic refined oil.
Comparison of major crude oil futures in China and foreign countries
1. China crude oil futures’ design features
Crude oil futures are China's first open futures. The biggest highlights and innovations of the contract design plan are “international platform, net price transaction, bonded delivery and RMB-denominated prices”. The “international platform" means internationalization of transactions, internationalization of settlement and internationalization of delivery, so as to facilitate the free, efficient and convenient participation of domestic and foreign traders. The “net price transaction” means that the prices do not include the tariff and value-added tax, and this avoids the impact of tax policy changes on the transaction price. “Bonded delivery” is a kind of physical delivery based on bonded warehouses. “RMB-denominated prices” means RMB is used for trading, settlement and delivery, and foreign exchange funds such as the US dollar are accepted as security deposit. In terms of delivery varieties, the target identified by crude oil futures contract is medium sulfur-containing crude oil, and the deliverable oils include UAE Dubai crude oil, Upper Zakum crude oil, Oman crude oil, Qatar marine oil, Yemen Masila crude oil, Iraq Basra light oil, and China’s Shengli crude oil.
2. World’s major crude oil futures
The comparisons of the main indicators of China's crude oil futures and the world's three major crude oil futures, namely Brent, WTI and Dubai, are as follows:
(1) Trading varieties: medium sulfur-containing crude oil for China and Dubai and light low sulfur crude oil for Brent and WTI.
(2) Trading units: 1 000 barrels per lot for all four futures.
(3) Quotation currency: China crude oil futures uses RMB while Brent, WTI and Dubai use US dollars.
(4) The minimum price change: RMB0.1/ barrel for China’s crude oil futures and US$ 0.01/barrel for Brent, WTI and Dubai.
(5) Delivery mode: physical delivery for China, WTI and Dubai, and cash delivery for Brent.
(6) Maximum daily price fluctuation limit: for China crude oil futures, it is not exceeding 4% of the settlement price on the previous trading day; for WTI, it is not more than US$10 higher or lower than the previous day’s settlement price, and if it reaches the limit of fluctuation, the transaction will be suspended for five minutes; there is no limited for Brent and Dubai.
(7) Trading time: for China crude oil futures, it is 9:00 to 11:30 and 13:30 to 15:30 Beijing time, and the continuous trading time is 21:00 to 2:30 of the next day; for Brent, it is 1:00 to 23:00 London time; WTI is 6:00 pm New York time to 5:00 pm of the next day; Dubai is 7:00 Singapore time to 6:15 of the next day.
Analysis of further functions of China crude oil futures
1. Cultivate a large number of market participants and enhance the international level and activity of traders
Although China's crude oil futures are internationalized contracts, due to the insufficient financial openness and limited capital control in China, it is still a big challenge to attract a large number of international investment entities to participate in China's crude oil futures trading in the short term. The main bodies of China's crude oil futures market will still be domestic oil producers, refiners, trading companies, financial institutions and companies and investors related to the oil business. It is practical to let enterprises having crude oil import rights and imported crude oil use rights fully realize the risk management functions of the crude oil futures, and thus effectively promotes the active participation of international energy companies, international traders and international financial institutions who are closely related to them.
2. Continue to study the impact mechanism of crude oil futures prices
The current international crude oil price system uses the price discovery function of the futures market to establish a pricing mechanism, especially using Brent and WTI futures contracts as the international crude oil pricing benchmark. The Shanghai crude oil futures market is expected to be forged into a platform that reflects the supply and demand of the domestic market and realizes the marketization of crude oil pricing in China. Therefore, it is necessary to continuously track the operation of the Shanghai crude oil futures market and calculate the floating prices of crude oil on the basis of comparing the benchmark price of Shanghai crude oil futures and calculating the premiums and discounts, so as to provide a basis for improving the formation mechanism of crude oil spot prices.
It is also necessary to pay attention to the pricing model of crude oil spots and straighten out the linkage of the spots and futures prices in the industrial chain. It is important to further study how to use Shanghai crude oil futures as the benchmark of the refined oil pricing as the current domestic refined oil pricing mechanism is too closely related to foreign crude oil prices, not conducive to avoid price risk. It is recommended to replace the contracts based on Brent, Dubai and Minas with the contracts based on Shanghai crude oil futures after the Shanghai crude oil futures contracts operation becomes more mature.
3. Improve the trading system of the crude oil futures market, improve market liquidity and transparency, and serve the real economy
The trading system of the futures market and the liquidity and transparency of the market, which is the authoritative basis of the futures market, should be improved with crude oil futures as the carrier. At the same time, the establishment of a dynamic information release mechanism and information disclosure platform is the guarantee for the continuous development and growth of the market. As part of the development of the crude oil futures market, the crude oil industry data (including inventory, production, demand, transportation and other relevant aspects) should be fully and comprehensively announced to promote the development of the futures market.
The “One Belt, One Road” platform should be used to encourage countries along the belt and road to use RMB in the settlement of crude oil trades, thereby increasing the utilization rate and recognition of the RMB in the actual trades of crude oil. Through such trades, the RMB can be gradually transferred from the denomination currency to the settlement currency. Futures companies should strengthen their research on the futures market, actively understand the needs of physical enterprise customers, closely track inventory and other basic data, predict price trends, increase the transparency of price formation, and create good conditions for the real economy to make better use of the futures market.
4. The application of Shanghai crude oil futures can be involved in many aspects
(1) Use the main contract of Shanghai crude oil futures for hedging. For example, lock the prices for the crude oils delivered in the future, hedge the price risk exposure of related goods and manage the price risk of crude oil inventories.
(2) Use Shanghai crude oil futures for cross-regional and inter-temporal arbitrage. For example, optimize the refineries’ sulfur-containing crude oil procurement plan, optimize the allocation of high and low-sulfur crude oil resources, carry out cross-regional trade arbitrage of domestic and foreign crude oil, reserve inventory resources or revitalize warehouse receipts.
(3) Use Shanghai crude oil futures for resource allocation and hedging. Crude oil is the basic energy resource and its prices are the indicator of other energies’ prices. We can use the main contract of Shanghai crude oil futures to carry out crude oil asset allocation and cross-varieties and cross-industries hedging.
