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OPEC says China’s oil futures contract promising but ‘has a long way to go

OPEC said a new Chinese oil futures contracts hold promise, but still has “a long way to go” before being accepted as a regional benchmark.

The Shanghai International Energy Exchange launched a yuan-denominated crude futures contract on March 26, in an effort to make inroads into a market dominated by dollar-denominated West Texas Intermediate crude CLK8, -0.63% the U.S. benchmark, and Brent crude its global equivalent.

The contract allows delivery of seven grades of medium-sour crudes that are prevalent in the local market—Basrah light, Dubai, Masila, Oman, Qatar Marine, Upper Zakum and China’s Shengli crude. All are heavier and more sour than Brent and WTI, which could make it “a far more useful marker for China and other major regional importers,” OPEC said in its monthly report. Sour refers to oil containing impurities, including sulfur, that must be refined.

And China has emerged as a major force in the oil market, the cartel noted, taking in 8.5 million barrels a day in 2017 to surpass the U.S. as the world’s biggest crude importer.

The goal behind the contract is to establish a futures contract that will aid the price discovery process and assist companies in mitigating risk while establishing a regional benchmark as an alternative to European Brent and Dubai Oman crude.

The “main risk factor” facing western investors, however, centers on the degree to which the INE contract is “independent from government interference,” OPEC said, “which is in addition to currency risk given that the contract is settled in yuan.

Liquidity is another issue, the report said, given the limited number of potential buyers for physical delivery at bonded storage facilities in China. Nevertheless, OPEC said, the new contract should be useful as a hedge for physical purchases, as well as for arbitrage play, which could also significantly boost DME Oman crude contract volumes on the Dubai Mercantile Exchange, according to the report.

Once established, China’s reference crude price could act as a regional benchmark for negotiations of spot or term crude-oil prices, of which around 60% are supplied by OPEC member countries, the report noted. That means Middle Eastern producing nations will watch closely and could eventually face pressure from Chinese buyers to adopt the benchmark for pricing physical crude contracts, the report said.

But despite an upbeat start, the contract “still has a long way to go to build up a history and reputation,” OPEC said. “Volumes and open interest will be the key measures of success and should be closely monitored going forward.”
Source: MarketWatch

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