FEATURE: Risk-hedging Chinese investors flock to LPG futures for arbitrage trade

Singapore — Chinese fund houses, investors and end-users are swarming to the Dalian Commodity Exchange since the launch of LPG futures and options in March, to hedge their positions against the Singapore over-the-counter LPG swaps market and to speculate, trade sources told S&P Global Platts in the week of July 26.

Heralding a growing trend, Chinese sources said fund houses based in Hangzhou were hedging domestic wholesale prices against the Saudi Contract Price and Argus Far East Index, or FEI.

These houses manage funds from various sources including PDH operator such as Soft Packaging Group, and other importers, as well as end-users to bid up the CP and FEI swaps ahead of the release of the Saudi August term Contract Prices on July 28.

Around mid-May, these funds bought some 200,000 mt of swaps, sources said.

The DCE publishes LPG price to reflect wholesale prices from selected import terminals in China, sources said.

"So fund houses can earn money by doing arbitrage between FEI or CP and DCE," one source said, adding this is also helping to further boost the already liquid regional LPG swaps market.

Hedging import margins

Another Chinese source said since the Dalian Commodity Exchange, or DCE, came online, "there is a way to hedge import margins. That's why a lot of funds are buying CPs to lock in margin."

Import margins in mid-May were around Yuan 800/mt-Yuan 900/mt before narrowing to Yuan 500-600/mt over the week ended July 25, the source said, adding it would narrow down further since futures price are under pressure.

"A lot of hedge funds are shorting the spread," the source added.

Market sources said while importers of residential LPG supply are keen to hedge their positions, some see this as a new practice and they need to weigh the risks of trading futures.

The trading volume and open interest of the most active November 2020 contract were 85,116 lots and 10,171 lots, respectively, on March 30 -- the first trading day of LPG futures on the DCE.

Trading volumes and open interest of the November 2020 contract, rose to 196,024 lots and 95,371 lot, respectively, on July 29, data released by the DCE showed.

"The trade was active ... now mainly funds and non-industrial companies participated in the LPG futures trading on DCE," a source in east China said.

Trade sources said there have been some trading and speculation opportunities on DCE's LPG futures contract as its price was nearly Yuan 1,000/mt above wholesale prices in the spot market.

The settlement price for November 2020 contract was Yuan 3,910/mt on July 29, while the LPG wholesale price was around Yuan 2,950/mt in South China, sources said.

"We have sold some November 2020 contracts on DCE, taking the opportunity of the large price gap," said another source with a company that has been trading on the exchange, adding that Yuan 1,000/mt has been enough to cover the storage fee for four months.

"The futures-spot speculation is only suitable for those players who have big and spare storage capacity," the source said.

Some players were said to have sold DCE LPG futures contracts and bought swaps in the overseas market, also taking the opportunity of large price gaps between the two markets.

"They expected the price gap to narrow down towards the delivery month, so that they can make money from the trading," the first source said.

Further growth seen

Some other LPG companies said they are also preparing to participate in LPG futures trading on the DCE.

"We are preparing now. The trading volume of the LPG futures is expected to grow further in future," said a third source in East China.

There are currently 13 designated LPG delivery warehouses owned by CNOOC -- Yangjiang, Dongguan JOVO, Guangzhou Huakai, Jiangmen Xinjiang Gas, Zhejiang Wuchan Chemical, Yantai Wanhua, Guangdong PetroChina Kunlun LPG, Chaozhou Ouhua Energy, China Gas Holding Guangxi, Fujian Huaxing Petrochemical, Fuzhou Zhongmin New Energy, Ningbo Platinum LPG, and Zhejiang Saige Energy, sources said.

Most of the designated LPG delivery warehouses are the first-tier LPG receiving terminals, while a few are second-tier receiving terminals.

However, some of the delivery warehouses were said to be unwilling to issue warehouse receipts, as the validity period for LPG futures warehouse receipts is several months, during which price volatility for domestic LPG could be large, market sources said.

"We also concerned about the price volatility within the validity period of the contract," said a fourth source with one of the delivery warehouses, "If we issue the warehouse receipt to a buyer in November and they take delivery of the cargoes in January or February, the price could be much higher in the latter time as LPG price is normally higher in colder weather."

Sources said there will be new measures to reduce the impact of price volatility on LPG futures delivery.

"After all, it's still around three months from the delivery month," the source added.

The China Securities Regulatory Commission, or CSRC, said futures and options trading will provide industrial companies with open, continuous and transparent price signals and effective risk management tools that will help promote stable operations of related companies at the world's top importer and consumer of LPG where consumption reached 47.06 million mt in 2019, accounting for about 14% of global consumption.

The launch came amid the coronavirus pandemic and plunging crude prices. The move was seen as offering investors some tools to manage market volatility risks, in a country where the average annual consumption growth rate in the past decade is 8%, LPG output in 2019 ranked third globally at 27.79 million mt, while imports were 20.68 million mt, mainly from the Middle East.