China’s next move to open up its commodities markets may be a step change.
As of Thursday, overseas investors will be able to trade copper futures on the Shanghai International Energy Exchange. It’s not the first such product: A yuan-denominated crude oil contract, launched in March 2018, has been modestly successful.
A subsequent push to let foreigners trade iron ore in Dalian established a global benchmark. Copper could outshine these efforts, thanks to fortuitous timing, global appetite for an economic bellwether and the sheer clout of the world’s largest consumer.
The ambition is clear. Beijing wants increased pricing power in the commodities markets it dominates, specifically when the country imports that ingredient. It no longer wants to be just a price taker.
China also wants to bolster use of the yuan for transactions overseas, part of a sputtering, long-term strategy to raise the profile and influence of the currency. At the same time, the government wants domestic companies to do more to hedge against volatility. Allowing foreigners to trade oil and iron ore — along with rubber, low-sulfur fuel oil and purified terephthalic acid or PTA, a petrochemical derivative — goes some way toward all of that.
Copper promises to be an even bigger advance. The metal is a key indicator for an economy that has recovered faster than the rest of the world from the coronavirus. While there is an existing contract on the Shanghai Futures Exchange, intended for local traders, the new one, traded on subsidiary INE, will be open to foreigners.
The contract size is the same, but this one will exclude tax and customs duty, and will be delivered into bonded warehouses, helping it compete actively with the London Metal Exchange.
Benchmarks are hard to create, as the oil market shows. Initiatives to shift away from established U.S. dollar contracts, such as Urals crude on the St. Petersburg exchange, have faltered. Shanghai’s yuan-based contract is the country’s first, and perhaps most dramatic, endeavor in international futures markets.
While performing relatively well, it hasn’t become an indispensable benchmark or caught up with Brent and West Texas Intermediate in volume, let alone in open interest, the number of futures contracts outstanding. A worrying spread that opened up in the spring, suggesting a distorted market, has now rebalanced.
Iron ore has done better. Here, China opened up an existing contract on the Dalian Commodity Exchange that was already among the country’s most liquid derivatives. While China accounts for about 14% of the world’s oil consumption, it’s the biggest steelmaker. Last year, Dalian traded more than 30 times physical seaborne volumes. As significant, more producers, including mining giant BHP Group, are agreeing to payments in yuan.
The timing for copper is right. China now accounts for more than half the world’s consumption, according to BMO Capital Markets, up from 39% in 2010 and 12% in 2000. The country’s appetite has only grown this year — it took in more unwrought copper and has already increased its purchases of refined metal by more than 1 million metric tons compared with 2019. It’s indicative that when broker BANDS Financial Ltd. did a presentation on the new contract alongside the Shanghai Futures Exchange, it was viewed 15,000 times by the next morning.
There is always the risk of unexpected government intervention, as seen in the past. From China’s perspective, copper isn’t going to fix the problem of yuan internationalization either. It may have to add warehouse locations to compete effectively with the LME. It could become useful, while not essential.
Still, establishing a credible regional benchmark is about the alchemy of timing, structure and luck. This may well have all three.
(By Clara Ferreira Marques)