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London — * Recent volatility rattles Beijing
* Contract size could be raised
* Adding Iranian crude under discussions

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China's first crude oil futures contract is unlikely to be launched this year as Beijing wants to tighten regulations so as to prevent the kind of volatility the equity and steel markets were facing.

While some key personnel changes at the host exchange had slowed progress towards launching the contract this year, there was also ongoing debate about whether to include Iranian crudes in the basket, even at a later date, officials with knowledge about the matter told S&P Global Platts last week.

"The China Securities Regulatory Commission is waiting for a nod from the state council before giving the green light to launch the contract," said a source close to CSRC, the top regulator for futures markets in China.

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Another official said that Beijing wanted to move very cautiously as the contract is designed for international participation.

"It is unlikely that the contract will be online this year. The contract is priced in yuan and it will be traded internationally. Any wild movements would damage the reputation of the currency, which is being promoted to be an international currency," he said.

The sharp plunge in stock markets last year and early this year, as well as the sudden surge in steel futures have put pressure on the government to put in place policies that can prevent extreme volatility and speculation in crude futures, he added.

The Shanghai Composite Index, a key index of China's domestic stock market, collapsed by more than half in around two months from a seven-year high of 5,178 reached in June 2015, as speculators took advantage of policy loopholes.

In addition, the steel rebar futures on the SHFE, which has become a global benchmark for the spot market, surged nearly 32% in a month to a 19-month high on April 21, 2016, as a wave of speculative funds entered the market. It then turned downhill and dropped over 32% in a month.

A series of measures to rein in prices, including increased trading margins and fees, proved ineffective.

The SHFE has been developing the medium sour crude futures contract since around 2009, although progress has picked up since 2012, its launch has been delayed many times.

STAFF CRUNCH

Meanwhile, the host for the contract, the Shanghai International Energy Exchange, has also lost a number of key personnel to develop and manage the futures contract, according to sources.

INE is a wholly owned subsidiary of SHFE in the Shanghai Free Trade Zone. Chu Juehai, who was the CEO, resigned from INE early this year. A few other senior officials have also resigned.

In addition, the CSRC and INE are also studying the crude price trend to find a good window to launch the contract to ensure its success.

"It is better to launch it when crude prices are low, as it encourages buying interest," said the second official.

CONTRACT SIZE

"The contract has been designed and is almost ready for launch, except for a few small changes -- such as finalizing the contract size and whether more delivery grades are needed to be added to the basket," said the first source.

According to the latest draft seen by Platts, it will be a medium sulfur crude futures contract, which will be priced in yuan. It will be physically settled, bonded delivery will be allowed and the contract size will be 100 barrels per lot.

"The CSRC is thinking to lift the contract size to 500 barrels a lot or 1,000 barrels a lot," the source said.

Lifting the contract size would mean that additional funds would be needed by the members to participate in trading. As a result, it has raised concerns that the number of participants meeting the requirement would fall.

"The liquidity of the contract is expected to remain good even if the contract size rises," one source added.

The crude contract has attracted a lot of interest -- both domestic and overseas. Participants were actively looking at setting up trading branches and teams in Shanghai, where the contract will be hosted.

Sinopec's trading arm, Unipec, the biggest Chinese crude trading company by volume, recently set up a branch in Shanghai for the contract, while Chambroad Petrochemical, the first independent refinery to buy spot crude from Saudi Aramco, also has a team in place in Shanghai.

IRANIAN CRUDE

"INE and CSRC are also considering whether to add Iranian crude into the deliverable crude basket due to China's heavy imports from the country. Sanctions against the supplier has also ended," the first source said.

Iran supplied 567,000 b/d of crude to China over the first five months of this year, making it the sixth-largest supplier.

"Additional crude grades would not be added unless the futures runs well after being launched," he said.

Based on the existing draft contract, the INE plans to allow physical delivery of seven grades of crude oil -- Basrah Light, Dubai, Masila, Oman, Qatar Marine, Shengli and Upper Zakum. Except Shengli, which is a domestic grade, all the other crudes are from the Middle East.

Limited storage availability for the futures delivery is also a hurdle.

China has seen a significant increase in crude oil stocks this year and some tanks, which had been earmarked to store crude oil for the contract's physical delivery, are currently occupied.

INE had previously indicated it intends to allocate 5.35 million cu m, or 33.65 million barrels, of storage space in bonded zones along China's coastal region to store crude traded under the futures contract.

--Oceana Zhou, oceana.zhou@spglobal.com
--Edited by Sambit Mohanty, sambit.mohanty@spglobal.com and Haripriya Banerjee, haripriya.banerjee@spglobal.com