The launch of China’s oil futures contract last Monday marks the biggest shake-up in pricing crude for years.
Grandiose claims have been made for it – that it will entirely transform oil price determination, or even lead to dethroning the dollar as the world’s reserve currency. However these scenarios turn out, this new contract does create concern for the Middle East countries and their premier export.
World oil pricing has long been based on two benchmarks: Brent crude from the North Sea, quoted on the Intercontinental Exchange, and West Texas Intermediate (WTI) in the US, on the Chicago Mercantile Exchange. Both are light, sweet (low-sulphur) oils, freely traded in dollars, and available from a wide range of producers. Deep and liquid futures markets allow participants to hedge their risk – whether an oil producer seeking to lock in higher prices, or a refiner ensuring its feedstock cost does not escalate. This activity is helped by the much-maligned “speculators”, who provide liquidity, and may themselves be seeking to lay off macroeconomic risks correlated to oil.
Both markers have problems. WTI is a land-locked crude with constrained pipelines to reach world markets, while US output increasingly comprises very light oils from shale that do not easily suit refineries. Brent production from the North Sea has long been declining, requiring more and more grades from other fields, some very different in composition, to be added to the physical basket that underpins it. And local accidents to ageing infrastructure – such as December’s shutdown of the cracked Forties pipeline – disturb global prices.
The third major benchmark, Dubai-Oman, is for sour (high-sulphur), medium-gravity crude, much more typical of Middle East production and of the grades sought in Asia, the centre of world demand growth. The Dubai Mercantile Exchange (DME) is the venue for trading Oman crude futures. These closely track the physical Dubai crude (which, confusingly, can also be substituted with Omani crude or Abu Dhabi’s Upper Zakum), whose price is assessed by specialist agencies and is the basis for most Middle East oil sales to Asia.
Since its launch in 2007, DME Oman has grown to be the world’s largest physically-delivered oil futures contract, but the quantity of financial trading still lags well behind Brent and WTI.
The new Chinese contract is distinctly different. Trading on the Shanghai International Energy Exchange (INE), it is denominated in yuan, and based in what is now the world’s biggest oil importer. Seven crude oils are deliverable against the contract, specific grades from Dubai, Abu Dhabi, Oman, Qatar, Yemen, Iraq and China’s own Shengli.
Notably, Saudi Arabia’s Arab Light is not on the list, despite its good fit for the specifications. Neither, even though Russia is China’s largest supplier, is East Siberian pipeline oil, too light and sweet to match the other crudes.
Why would the Chinese want to launch such a contract? It should better reflect the crude quality and supply-demand dynamics in the East Asian market than do the distant Brent and WTI. And it is part of China’s drive to trade more in its own currency, the yuan, as it has also been pushing with its Belt and Road infrastructure initiative throughout Asia.
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Oil makes up some 10 per cent of world merchandise trade, but ideas that this contract will dethrone the dollar as the world’s premier currency are overstated. Major shifts in global reserve currencies take time and often require dramatic political and economic realignments, as in the post-Second World War changeover from the pound sterling to the dollar. The dollar is losing ground to the yuan (and euro) but the yuan is still not freely convertible.
For now, INE’s higher fees, higher margin requirements, restrictions on crude imports into China, the need to hedge the yuan against the dollar, mismatched trading times and closure during Chinese public holidays are all deterrents to its wider take-up by outside traders.
On its first few days, the Shanghai contract has traded about four times the volumes of the DME, but its open interest, a measure of hedging, is still much lower. If this persists beyond its infancy, it would point to INE’s use for speculation rather than by commercial players seeking to avoid risk.
DME signed a cooperation agreement with INE in 2014. In principle, as they are based on similar underlying crudes, their two contracts should trade very similarly, the difference between them reflecting just freight costs from the Arabian Gulf to Asia. Based on very limited data, this is borne out so far, with INE above Oman and below Brent.
In this case, Middle East oil producers have nothing to fear, and INE may become an acceptable way for them to price their crude sales to Asia, even boosting its value by allowing easy hedging. Iraq has begun selling some of its crude by auction through the DME, but other than from Oman, most Middle East oil sales remain heavily restricted on permitted destinations and resale, limiting its value to traders.
But the Chinese government may interfere more heavily in the INE contract, to subdue volatility, dampen price spikes or simply move the market in ways it desires. Then the Middle East oil exporters may come to regret having lost control of the pricing of their key commodity.
Robin M Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis
Titanium Escrow profile
Started: December 2016
Founder: Ibrahim Kamalmaz
Based: UAE
Sector: Finance / legal
Size: 3 employees, pre-revenue
Stage: Early stage
Investors: Founder's friends and Family
The smuggler
Eldarir had arrived at JFK in January 2020 with three suitcases, containing goods he valued at $300, when he was directed to a search area.
Officers found 41 gold artefacts among the bags, including amulets from a funerary set which prepared the deceased for the afterlife.
Also found was a cartouche of a Ptolemaic king on a relief that was originally part of a royal building or temple.
The largest single group of items found in Eldarir’s cases were 400 shabtis, or figurines.
Khouli conviction
Khouli smuggled items into the US by making false declarations to customs about the country of origin and value of the items.
According to Immigration and Customs Enforcement, he provided “false provenances which stated that [two] Egyptian antiquities were part of a collection assembled by Khouli's father in Israel in the 1960s” when in fact “Khouli acquired the Egyptian antiquities from other dealers”.
He was sentenced to one year of probation, six months of home confinement and 200 hours of community service in 2012 after admitting buying and smuggling Egyptian antiquities, including coffins, funerary boats and limestone figures.
For sale
A number of other items said to come from the collection of Ezeldeen Taha Eldarir are currently or recently for sale.
Their provenance is described in near identical terms as the British Museum shabti: bought from Salahaddin Sirmali, "authenticated and appraised" by Hossen Rashed, then imported to the US in 1948.
- An Egyptian Mummy mask dating from 700BC-30BC, is on offer for £11,807 ($15,275) online by a seller in Mexico
- A coffin lid dating back to 664BC-332BC was offered for sale by a Colorado-based art dealer, with a starting price of $65,000
- A shabti that was on sale through a Chicago-based coin dealer, dating from 1567BC-1085BC, is up for $1,950
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Seek professional advice from a legal expert
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The Travel Diaries of Albert Einstein The Far East, Palestine, and Spain, 1922 – 1923
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Election pledges on migration
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Mercer, the investment consulting arm of US services company Marsh & McLennan, expects its wealth division to at least double its assets under management (AUM) in the Middle East as wealth in the region continues to grow despite economic headwinds, a company official said.
Mercer Wealth, which globally has $160 billion in AUM, plans to boost its AUM in the region to $2-$3bn in the next 2-3 years from the present $1bn, said Yasir AbuShaban, a Dubai-based principal with Mercer Wealth.
“Within the next two to three years, we are looking at reaching $2 to $3 billion as a conservative estimate and we do see an opportunity to do so,” said Mr AbuShaban.
Mercer does not directly make investments, but allocates clients’ money they have discretion to, to professional asset managers. They also provide advice to clients.
“We have buying power. We can negotiate on their (client’s) behalf with asset managers to provide them lower fees than they otherwise would have to get on their own,” he added.
Mercer Wealth’s clients include sovereign wealth funds, family offices, and insurance companies among others.
From its office in Dubai, Mercer also looks after Africa, India and Turkey, where they also see opportunity for growth.
Wealth creation in Middle East and Africa (MEA) grew 8.5 per cent to $8.1 trillion last year from $7.5tn in 2015, higher than last year’s global average of 6 per cent and the second-highest growth in a region after Asia-Pacific which grew 9.9 per cent, according to consultancy Boston Consulting Group (BCG). In the region, where wealth grew just 1.9 per cent in 2015 compared with 2014, a pickup in oil prices has helped in wealth generation.
BCG is forecasting MEA wealth will rise to $12tn by 2021, growing at an annual average of 8 per cent.
Drivers of wealth generation in the region will be split evenly between new wealth creation and growth of performance of existing assets, according to BCG.
Another general trend in the region is clients’ looking for a comprehensive approach to investing, according to Mr AbuShaban.
“Institutional investors or some of the families are seeing a slowdown in the available capital they have to invest and in that sense they are looking at optimizing the way they manage their portfolios and making sure they are not investing haphazardly and different parts of their investment are working together,” said Mr AbuShaban.
Some clients also have a higher appetite for risk, given the low interest-rate environment that does not provide enough yield for some institutional investors. These clients are keen to invest in illiquid assets, such as private equity and infrastructure.
“What we have seen is a desire for higher returns in what has been a low-return environment specifically in various fixed income or bonds,” he said.
“In this environment, we have seen a de facto increase in the risk that clients are taking in things like illiquid investments, private equity investments, infrastructure and private debt, those kind of investments were higher illiquidity results in incrementally higher returns.”
The Abu Dhabi Investment Authority, one of the largest sovereign wealth funds, said in its 2016 report that has gradually increased its exposure in direct private equity and private credit transactions, mainly in Asian markets and especially in China and India. The authority’s private equity department focused on structured equities owing to “their defensive characteristics.”
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