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Shanghai Oil Futures Are Turning Into Asian Benchmark, Study Finds
www.yicaiglobal.com
(Yicai Global) Dec. 13 -- Crude oil futures traded on the Shanghai International Energy Exchange are emerging as the commodity’s pricing benchmark in Asia, according to research by a team at the University of Colorado.
Prof. Jian Yang and his team based their conclusion on the daily frequency data of INE crude oil futures between March 26, 2018, when they began trading, and Dec. 31, 2020, he said in a speech made at Hunan University in China yesterday.
The team’s research showed that the dynamic price discovery performance of INE oil futures was driven by economic fundamentals and trading characteristics, he said. As the world’s top oil importer, China's unique warehousing delivery mechanism through these futures helped improve price discovery over time, leading to confidence among traders.
Cross-border price discovery of commodity futures for spot prices in other countries is rare and has not yet been thoroughly examined. Conventional wisdom has it that poor warehousing delivery conditions can negatively affect the price discovery process. As there was no international delivery warehousing in other countries for INE oil futures during the sample period, that implies an obstacle for good price discovery performance, Jian said.
The study found that there was a long-term link between INE futures prices and each of the original seven deliverable spot prices. Each of the deliverable spot prices and the INE futures prices reacted to each other over the long run, with both sets making almost equal adjustments to the long-run information. Looking at both short- and long-term information, INE futures prices on average can explain a quarter to a third of the price movements in each of the deliverable spot prices, which implies that INE pricing is an important source of information for pricing deliverable Asian crudes.
Jian’s team even found a similar good price discovery performance among INE futures for the UAE’s Murban crude oil, even before it was officially added as a deliverable grade at the INE this past June, he said.
The research also revealed that even though the temporary halt of nighttime trading damaged price discovery last year, it even improved to some extent after the recovery from Covid-19 in the second half of 2020. It is continuously driven by rapid growth in trading volume and open interest, a dramatic improvement in the market structure, including a higher share of trading volume and open interest by foreign investors, and particularly a much lower speculation ratio, as well as continuously improved market liquidity.
Foreign institutional investors’ share of trading volume rose to 18.65 percent last year from 7.46 percent in 2018, while open interest by overseas investors rose to 24.97 percent in from 14.2 percent in the same period, Jian said. Meanwhile, the speculation ratio for the first active contract fell to 2.65 percent on average from 7.7 percent, he said.
Still, much room remains to improve the price discovery function of INE oil futures. In particular, deliverable spot prices still played a somewhat more important role than INE futures prices in the process. At one or two days, about a quarter of the price movement of futures would be driven by spot fluctuations in the Middle East, but the degree of influence of spot prices on futures increases significantly over time, explaining about two-thirds of the INE futures prices each month.
In addition, the study also found that INE pricing emerged as a benchmark for all major types of crude oil used in Asia, even those not deliverable against INE futures. Among another 11 spot prices for non-deliverable oil in Asia, INE futures also have good price discovery performance for four of them, including Saudi Arabia’s medium crude to Asia and Russia’s ESPO, the No. 1 and No. 2 oil imported to China in recent years.
