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Get ready! March 26, 2018 marks the opening of trade of the new gold-backed, Yuan denominated Chinese oil futures contract. The contract will be traded on the Shanghai International Energy Exchange with similar sizing as the West Texas Intermediate contract traded on the NY-MEX: 1,000 barrels/lot; tic value equal to 0.1 Yuan per barrel, or 100 Yuan; a 4% +/- daily price limit on monthly or quarterly contracts, and a 5% minimum trading margin required. World investors will be allowed to trade the contract, which is a first for a Chinese market.

The stated purpose of the new contract is to offer a hedging system for industry that more accurately reflects “…the demand-supply relationship in Asia-Pacific,” by pegging the contract to the medium sour grades of crude that are consumed by local refineries. A subtler purpose is for China, now the world’s largest oil importer, to shift the world petro-currency of choice from the petro-dollar to the petro-yuan. Such a shift would reduce China’s exposure to the United States’ economic sanctions as well as give it expanded clout on the world stage. This possibility however, is far from inevitable.

The Yuan itself is a limiting factor as the Chinese government heavily regulates its value as well as capital outflows from the country. Additionally, investors generally are not keen on markets they perceive to be dominated by the Chinese government and few other players. The threat of government intervention looms as the Chinese government has proven its willingness to meddle in other Chinese commodities markets in the past. Finally, low levels of liquidity may also limit trading in the petro-yuan as bid-ask spreads are much wider in Chinese markets, leading to higher trading costs and increased volatility.

Generally, the consensus among experts is “Don’t Panic!” However, the new contract could be a beach head for the Chinese government to divert more international trade from dollars to yuan.

Click HERE for Sungwoo Park’s article on Bloomberg Business Week, which offers the best summation of the new contract and the issues surrounding its issue.

 

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