As China seeks to establish a global oil benchmark at home, it wants to prevent a speculative bubble in its upcoming crude futures.
While contracts for everything from apples to steel change hands in China with an intensity that makes trading in the world’s more established exchanges look placid, the fervor has undermined their reliability as benchmarks. The top user of most commodities wants to avoid that pitfall when it launches yuan oil futures next week in a bid to encourage the global use of its currency.
One of its strategies to deter excessive price swings is to set related crude storage costs in China at levels that are at least twice the rate elsewhere. That’s seen discouraging speculators interested in conducting so-called cash and carry trades, which seek to take advantage of differences between the spot price and futures of a commodity.
“The government would rather have a slightly slower or softer launch — and I think there will be enough interest to ensure quite a strong launch nonetheless — than to have to intervene very early on in a market that is bubbling too quickly,” Michal Meidan, an analyst at industry consultant Energy Aspects Ltd., said in an email.
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The yuan oil futures will begin trading March 26 on the Shanghai International Energy Exchange, a unit of the Shanghai Futures Exchange. Foreign traders will be allowed to invest directly — a first for China’s commodities markets. Trading in raw materials across the nation’s three main bourses has exploded in recent years, with regulators repeatedly stepping in to quell fears of a bubble during particularly wild bouts of activity.
The daily trading band for the crude oil futures has been set at 5 percent on either side, and 10 percent on its debut day, while margin requirements are at 7 percent. Earlier this month, Chinese speculators traded $11 billion worth of apples in just four hours on the Zhengzhou Commodity Exchange. A few days later, the bourse raised the daily trading fee for futures of the fruit.
The cost to store crude oil for delivery into the Shanghai Futures Exchange is said to be set at 0.2 yuan a barrel per day, equivalent to about 95 cents a barrel per month. That’s subject to further negotiations between counterparties. By contrast, Matrix Global Holdings sold storage capacity at the Louisiana Offshore Oil Port in the U.S. at a monthly price of about 5-7 cents a barrel via an auction in March.
“Storage plays a crucial role in linking cash and futures markets,” said Jian Yang, J.P. Morgan endowed chair and research director at the J.P. Morgan Center for Commodities in the University of Colorado Denver. “Many speculators such as proprietary traders and hedge funds may be scared away” he said, adding that monthly international storage costs are estimated to be in the range of 25-50 cents a barrel.
The Shanghai Futures Exchange’s press office declined to comment.
While the Chinese futures will start trading later this month, the first contract is for oil to be delivered only in September. The current structure of the market — where near-term futures are more expensive than longer-dated contracts — makes it uneconomical to hoard crude for long periods while paying such a high storage expense, said John Driscoll, the chief strategist at JTD Energy Services Pte. Taking other costs such as financing into account, the charges may exceed $1 per barrel, he added.
“The government has been eager to encourage liquidity and paper trading, but of course the issue with paper trading is speculative trading that the government wants to keep at bay,” said Energy Aspects’ Meidan.
There’s enthusiasm for the new crude futures contract among Chinese brokerages and retail investors, given that this is a new avenue for placing money, she said. So the government may end up restricting wild activity, at least in the early days of the contract, according to Meidan.
Still, there’s a risk to success in the longer term. “High storage costs could prevent the necessary arbitrage between cash and futures markets, which further significantly reduces the price discovery function of the contract,” said Yang at the University of Colorado Denver. “Without a good price discovery function, no futures contracts can eventually be successful.”