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China inches closer to launching its first crude futures contract

Singapore (Platts)--14 Jan 2018 1118 pm EST/418 GMT


China is inching closer to launching its first crude oil futures contract but it will happen only after the Lunar New Year holiday which ends on February 23, a government source with knowledge of the matter said.

"Basically, there is no problem [for the crude contract] to get approval from the State Council," the source said, but added that it was unlikely to be kicked off before the Lunar New Year.

Approval from the State Council is the final hurdle in the launch of the medium sour crude futures contract.

Once it is approved, the exchange will release the deliverable crude grades, differentials of the deliverable grades against the standard contract and the delivery venue, a source with host platform Shanghai International Energy Exchange said recently.

"The exchange should officially release these details two weeks ahead of the launch in order to give enough time to inform the potential players," said a futures trader in South China.

Given this schedule, analysts expect the earliest launch date as most likely in late March after China's most important annual political events in early to middle March -- the National People's Congress and the Chinese People's Political Consultative Conference.

INE's parent company, the Shanghai Futures Exchange, has been developing the medium sour crude futures contract since 2009, with some progress seen between 2012 and the third quarter of 2015. The launch of the contract has been delayed several times.

Although it had been widely expected to start up in 2017, INE only announced the basic terms and general trading rules while accepting more members and carrying out several trial runs for the system.

MARKET CAUTIOUS

Despite the delays, the Chinese yuan-denominated contract, which allows international participation, kept drawing more attention from not only domestic, but also foreign market participants.

In theory, this crude oil futures contract could become a major oil price benchmark that would reflect East Asia's point of view on where the market and prices should be, international oil traders said.

"Nobody would want to miss out that's for sure. Many Asian firms have yuan exposure through businesses in China/Hong Kong, so the currency won't be too much of an issue," said a Singapore-based crude oil trader.

Beijing has been keen to develop the contract and turn it to an international benchmark on the back of China's massive crude oil import volume of around 8 million-8.5 million b/d.

But the biggest worry among both domestic and overseas participants would be liquidity and sharp volatility in the early phase when it is launched, trade sources said.

"We will take part in the early stage when it is launched, but only as a hedging tool ... a new contract ... [can be] risky," a Shandong-based refiner said.

"In fact, Beijing is more worried about volatility than liquidity," the government source said.

The government in 2015 allowed independent refiners to refine imported crude oil, which helps to improve domestic participation. Before that, only the state-owned refineries were allowed to refine imported crude oil.

This will allow more physical crude oil end-users, in addition to the state-owned ones, to participate in trade of the futures contract.

In addition, Beijing has announced a series of special policies on taxation, foreign currency exchange and bonded delivery to enable and encourage overseas participation.

The contract size also has been raised to 1,000 barrels a lot to buffer volatility, up from 100 barrels that was initially planned.

Raising the contract size means additional funds would be needed by market participants to trade.

"Generally, it is easier to grow a futures contract to become a benchmark in a hub both for crude production and consumption, such as the US and North Sea," said a refiner in northeastern China.

China is the world's second largest oil consumer but its crude production is on a downtrend.

Basic terms of China's crude futures contract

-- Oceana Zhou, oceana.zhou@spglobal.com

-- Philip Vahn, Philip.Vahn@spglobal.com, with Staff

-- Edited by Irene Tang,irene.tang@spglobal.com

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