A new crude oil benchmark is imminent: The Shanghai International Energy Exchange (INE), a unit of the Shanghai Futures Exchange, will launch a crude oil futures contract in the next couple of months. As we discussed in May of last year, China proposed this contract and shelved it many times in the past, but it is now finally going to come to fruition.
Crude oil futures contracts allow the buyer to receive a quantity of crude oil from the seller at a predetermined price at some point in the future. Benchmarks, the most commonly traded crude oil contract, are also used to help price similar grades of crude. Now, traders will have a new option - the Chinese crude futures contract.
How will this be priced?
There are a variety of factors that determine a daily crude oil price. One of the most essential aspects is the balance between global supply and demand. A crucial aspect of this balance is the level of inventories.
Companies use crude inventories as a way to handle supply and demand fluctuations, so producers meet deadlines and quotes, but inventories are also used heavily when future prices are expected to be higher than spot price, otherwise known as contango. The change in inventories is a leading indicator for movements in oil prices (holding additional factors constant) and in general, traders use data on inventories to predict future prices of commodities.
Every week, the U.S. Department of Energy publishes U.S. inventory levels, including those for Cushing, Oklahoma, a major storage hub. Upon release of this data, markets react, depending upon the difference between reported changes and expectations. With a new benchmark, inventory data continue to be relevant for determining prices. In a similar way that Cushing inventories affect West Texas Intermediate (WTI), Chinese inventories, if reacted upon, could cause movements in the Shanghai INE crude oil contract.
Looking at the relationship between Ursa’s Chinese crude inventory measurements and Brent crude price demonstrates the correlation between Chinese inventories and oil prices. The following chart illustrates a simple linear regression model, using measured and estimated Chinese crude inventories against Brent prices between 2014 and 2017. The R2 ~ 0.80 shows the explanatory power:
Brent Price vs. Model Using Ursa China Inventory Data
Seeing this relationship between Chinese inventory data and crude prices allows us to imply that this same relationship will exist with the new benchmark as well. Theoretically, this is even more so because the benchmark and inventories are in the same country.
Why does this matter?
When the Shanghai INE crude oil contract becomes live, it will be necessary to have reliable inventory data for China in order to accurately predict movements of the INE. Those who have up-to-date information will succeed and now that, for the first time, reliable weekly crude inventory levels are available for China, market participants will use it more frequently to determine movements in price. It will be an advantage to have a trustworthy crude oil balance for China each week. Learn more here about Ursa’s current Global Oil Storage product and reach out to us for more questions or to start your trial.