In March 2018, China launched oil futures on the International Energy Exchange (INE), Shanghai – the first step towards shifting the global oil trade to the Yuan from the U.S. Dollar, thus creating the Petro-Yuan. Six months on, this exchange already has a daily traded volume of over 200 million barrels, about half the volume of oil being traded on the International Commodity Exchange (ICE), London, a quarter of the volume on the New York Mercantile Exchange (Nymex)[1], and far ahead of all other global exchanges. At least on this one metric – trading volume – the Petro-Yuan seems to have succeeded, but on others, such as delivery volumes and range of contracts being traded, it will be a while before it can be a credible challenge to the Petro-Dollar.
Some numbers point to why the Petro-Yuan has not reached maturity. In the few months since its launch, Yuan-denominated trading on the INE, Shanghai reached a volume comparable to the established exchanges. On the last trading day of September 2018, a total of 247,122 oil contracts were traded on the INE Shanghai, corresponding to a volume (in paper) of 247 million barrels. This is almost 2.5 times the daily physical trade in oil globally – and seems to indicate that the Shanghai oil trade reached critical mass and scale quickly. But the current trading pattern on the INE Shanghai shows that over 99% of the trading volume currently is for a single contract, expiring in December 2018, with the remaining volume spread out over all the other contracts between now and 2021. The same pattern – a vast bulk, often exceeding 99% or more, of trading in a single contract – was visible in the period before the September 2018 contract matured.
Such a skew indicates that the trading in Shanghai is mostly speculative. For instance, if an oil producing company wants to hedge its future revenues, it will do so in line with future production – and therefore, will go for a mix of futures contracts with different maturity dates. Similarly, if a daily consumer of oil, such as an airline, wants to hedge future fuel expenses, it will again use a mix of futures contracts of varying maturities to match actual fuel consumption. If almost all the trading on exchange is going on in a single contract, this means that actual producers and users of oil are playing a very minimal role, and the trading volume is being driven by speculators.
One other factor indicates that the Shanghai Exchange trade has a very small base in physical trade: the low delivery volume. The first contract to reach maturity was the September 2018 future contract for oil, against which 601,000 barrels of oil were delivered[2]. This is less than one-third the volume of oil carried by one super tanker, and less than one-tenth of China’s daily oil imports. This very low volume of physical trade is for a contract that had hundreds of millions of barrels being traded (on paper) every day for a few months.
This imbalance in trading on the INE, coupled with the crash in 2015 of the Chinese stock market and subsequent bear market, suggests that some of the earlier speculation may have migrated to the commodity exchange. A report from a wire agency indicated that the average traded contract in China was held for two hours – as opposed to 65 hours in the UK – indicating its more speculative nature[3].
Another factor that will impede the Petro-Yuan’s smooth passage and the INE becoming a global trading hub is that foreign traders, oil users and consumers are likely to stay away from the Chinese commodity exchange. This is a fallout of the heavy-handed intervention of the Chinese government after the 2015 stock market meltdown when it threatened investors and short-sellers with arrest and forced them to buy and hold shares when they wanted to sell[4]. Foreign traders and companies, who are already trading on other global markets, are not likely to patronise an exchange where they cannot trade freely or withdraw funds at will. The absence of foreign participants inhibits the Petro-Yuan’s global adoption.
Every other major economy also follows the practice of publishing monthly import/export statistics for oil and a range of other commodities[5], but the Chinese government stopped doing so in May this year. This cast in doubt the transparency and reliability of data being reported from China. In the absence of any clear indications of demand/supply from the domestic market, the oil trade in Shanghai will not serve the purpose of price discovery – it will remain a tool for speculation, and the Petro-Yuan a pipe dream.
Amit Bhandari is Fellow, Energy and Environment Studies, Gateway House.
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References
[1] Gloystein, Hennings, Reuters, Shanghai crude futures eat into Western benchmarks as China pushes yuan, 31 August, 2018, <https://www.reuters.com/article/us-china-crude-oil-futures-analysis/shanghai-crude-futures-eat-into-western-benchmarks-as-china-pushes-yuan-idUSKCN1LF2RE>
[2] Reuters, Shanghai crude future for September expires with five companies to deliver oil, 31 August 2018, <https://www.reuters.com/article/us-china-crude-futures/shanghai-crude-future-for-september-expires-with-five-companies-to-deliver-oil-idUSKCN1LG10X>
[3] Bloomberg, Speculators Rattle China Oil Futures as Prices Break From World, 7 August 2018, <https://www.bloomberg.com/news/articles/2018-08-07/oil-speculators-grip-china-futures-as-prices-post-mystery-gains>
[4] Wong, Edward, Neil Gough, and Alexandra Stevenson, The New York Times, China’s Response to Stock Plunge Rattles Traders, 9 September 2015, <https://www.nytimes.com/2015/09/10/world/asia/in-china-a-forceful-crackdown-in-response-to-stock-market-crisis.html>
[5] Hari, Vandana, Nikkei Asian Review, China hides key oil data, leaving market players guessing, 26 September 2018, <https://asia.nikkei.com/Opinion/China-hides-key-oil-data-leaving-market-players-guessing>