Chinese Business Lifts Dubai Crude Oil Trades
$OIL
Chinese oil companies’ rapid switch of oil purchases from over the counter to exchange-based transactions has helped the 8-year-old Dubai Mercantile Exchange become a highly influential regional crude oil marketplace.
Within 8 years, Chinese oil imports have grown to account for 70% of the physical delivery of oil traded on the Dubai-based DME, compared with about 40% 3 years ago.
Such large purchases have made the DME’s Oman crude contracts a regional benchmark, on par with Brent crude of London and WTI crude in New York.
Oman crude has also become the largest physically delivered oil-futures contract in the world, largely driven by China’s high demand for oil. In comparison the Brent and the WTI are for crude oil more commonly traded as risk hedges.
“We are seeing an increase in activities from China, and we are happy with the growing cooperation with Chinese traders, Bank of China and the Shanghai Futures Exchange,” said Owain Johnson, managing director of the DME in the United Arab Emirates (UAE).
mr. Johnson said the exchange is attracting a growing number of Chinese traders, especially after it established a Chinese-language website and a regional office in Singapore to more efficiently liaise with Chinese customers.
In November, Bank of China signed a memorandum of understanding with the DME to cover the financing of Chinese companies’ purchase of oil from the exchange.
This agreement led to an announcement in July that Bank of China had instituted a policy of providing letters of credit to Chinese firms buying from the exchange, which demonstrates its endorsement for the exchange’s credibility. A letter of credit is an import financial instrument.
“Previously, much of the oil trade on the DME was financed by Western banks, but for the 1st time Bank of China is stepping into this space to finance trade deals,” Mr. Johnson said.
“It is often more economic for Chinese oil buyers to use a bank they already have a corporate relationship with, and working with Bank of China could also provide them with lower cost of financing and more logistic convenience.”
DME has established a close relationship with Shanghai Futures Exchange and will play an important role in helping the Chinese exchange establish its own crude oil contract by sharing its expertise and introducing its customers to the Shanghai Futures Exchange.
In addition, the two exchanges will share marketing platforms and maintain trading transparency for their respective customer bases, Johnson said.
“China has become our biggest customer so we have a big influence on the oil price in China, and likewise Chinese buyers have a big influence on our crude oil contract price, so we have been exploring how to make trades more efficient,” he said.
The Shanghai Futures Exchange has said that the new crude oil contract will be priced in RMB Yuan and will be structured by combining the prices of several key crude oil grades that constitute China’s oil imports, one of which will be Oman crude.
“China is the most important importer of oil in the marketplace and it’s crazy that they don’t have a benchmark contract for oil prices. The launch of the new contract in China will help Chinese traders have more pricing power over crude oil,” Mr. Johnson said.
With a crude contract in China, Chinese traders would be able to send a signal about their growing demand by increasing their purchase of the contract, which will in turn reduce oil prices. This increasing volume of demand is highly transparent because it is reflected on an organized exchange.
Without such a contract, the amount of crude oil Chinese traders demand would not be seen by the overall market, thus not contributing to determining the market price.
Johnson said the launch of the new Chinese crude oil contract will help increase trading volumes on the DME because the two contracts will help traders see arbitrage opportunities and execute trades to take advantage of the arbitrage.
Arbitrage means traders buy the cheaper contract and sell the more expensive one in order to pocket risk-less returns, as the underlying commodity of the 2 contracts is often the same.
Mr. Johnson said because the Middle East is a big exporter of crude oil, the Oman Crude contract is now seen as a reference price by oil exporters, and as China is a big importer its crude oil contract is likely to be seen as an import reference price.
“The fact that our contract is priced in dollars and the Chinese contract is priced in renminbi (yuan), and that one contract is an export benchmark and the other is an import benchmark means that our two prices will never be the same. The arbitrage opportunity will increase trade volumes,” he said.
Historically, Brent crude contracts worked as export contracts and the WTI an import contract, and the relationship between the 2 has been a Key influence on driving up trade volumes.
Launched in Y 2007, the DME is a subsidiary of the United States-based futures company CME Group (Chicago Mercantile Exchange & Chicago Board of Trade). Mr. Johnson said a Key objective for the DME’s founding was the launch of an Asian crude oil benchmark that fills a gap in the market.
Johnson said the association with CME has greatly helped DME’s growth, as CME has provided his team with its own trading platform technology, so the DME would not need to invest heavily into infrastructure at its founding stage.
From there on, it established credibility with a consistent service to traders, which led to a gradual accumulation of liquidity.
Before, much of China’s oil imports were bought OTC, meaning individual companies would negotiate oil prices. OTC negotiations are much more complex than buying a crude contract on the DME, and given the lack of price transparency, junior traders often found it difficult to justify the purchase price to managers.
Although Brent and WTI are open to foreign participation, a Key problem with the later is that the US-produced underlying crude oil cannot be taken out of the country, meaning it is purely a tool for financial speculative trading or crude oil purchases by US firms.
Brent crude, produced in the North Sea, is now seeing its volume decreasing, meaning the future sustainability of Brent exports faces uncertainty in the long term.
As much of the Asian markets’ crude oil demand is already satisfied by the Middle East production, the launch of the Oman crude contract has fulfilled big demand in the market. Apart from Chinese buyers, oil companies from Japan, South Korea, Singapore and Malaysia are also buyers of Oman crude, together making up about 30 percent of total trade.
Furthermore, the DME has focused heavily on physical delivery of oil by making sure the futures contracts match the physical delivery of the underlying crude, and this fits well with the Chinese government’s objective to encourage the use of commodity trading for physical delivery as opposed to speculative trading.
This characteristic distinguishes the contract from the other crude oil exchanges, where a large volume of the trade is focused on the profit or loss at contract expiry, rather than the commodity changing hands.
By Cecily Liu
Paul Ebeling, Editor
HeffX-LTN
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