China took another step forward in its plans to open up the country’s financial markets and increase its pricing power over globally traded commodities with the launch of yuan-denominated crude oil options contracts, the first in the energy sector available to foreign investors.
The contracts started trading on the Shanghai International Energy Exchange (INE), part of the Shanghai Futures Exchange (SFE), on Monday, following Friday’s launch of yuan-denominated palm oil options on the Dalian Commodity Exchange, which are also open to overseas investors.
China has pledged to develop its derivatives market and give greater access to overseas investors who have long complained about the lack of hedging and derivatives instruments available on Chinese mainland markets that would allow them to bet both ways on the direction of stocks, bonds and commodities and manage their risks. China also wants to build up the country’s influence on global commodity markets to give it greater pricing power that reflects its status as the world’s biggest importer of crude oil (link in Chinese) and second-largest buyer of palm oil.
That’s already happening in crude oil futures trading. In March 2018, the INE launched yuan-denominated crude oil futures, China’s first commodity derivative open to foreign investors. The trading volume of INE crude oil futures, which are based on the price of Middle Eastern crude oil known as “medium sour,” is now the third highest in the world, following West Texas Intermediate (WTI) crude futures and Brent crude futures traded mostly in New York and London, according to the INE.
Oil companies mainly use crude oil futures for hedging, but the introduction of crude oil options provides a “good supplement,” said Jiang Yan, chairman of the SFE. Companies can not only hedge risks through a combination of options and futures products, but there’s also the potential to make a profit from fluctuations in the underlying oil price, Jiang said (link in Chinese).
Trading in the new crude oil options contracts got off to a muted start on Monday with trading volume and open interest (contracts not yet settled) standing at 4,475 lots and 1,652 lots respectively at the close of business, with turnover at just 50.7 million yuan ($7.8 million). Analysts said that was normal for a new options contract in China and that it will take time to attract liquidity into the market.
Companies involved in the first batch of trades included (link in Chinese) Citic Securities Co. Ltd., the Hong Kong and East China subsidiaries of PetroChina International Co. Ltd., an arm of state-owned oil giant PetroChina Co. Ltd. (601857.SH), and commodities traders Trafigura Group Pte. Ltd., Mercuria Energy Group Ltd. and Freepoint Commodities LLC.
The volatility in global crude oil prices over the past year has fueled demand in China for hedging instruments. The price of crude oil collapsed as the outbreak of the coronavirus spread across the world, leading to the shutdown of vast swathes of the global economy. But since the beginning of this year, as major economies have recovered, oil prices have surged. WTI crude has risen by around 48% and the INE’s SHFE Sour Crude Oil Commodity Index has jumped by about 50%.
But within the overall trend, there have been sharp fluctuations. On March 18 for example, the price of WTI crude fell by 7.1% in just one day and on April 14 it jumped 4.9%. On Wednesday, the U.S. Federal Reserve surprised markets by saying it was considering starting a discussion to scale back the financial support it had provided to the markets during the Covid-19 pandemic and that it may start to raise interest rates sooner than originally anticipated. The comments led to a spike in the dollar and a drop in the price of crude oil.
Contact reporter Tang Ziyi (ziyitang@caixin.com) and editor Nerys Avery (nerysavery@caixin.com)
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