China’s launch this week of a crude oil contract on the Shanghai Futures Exchange (ShFE) allows investors for the first time to take advantage of differences in supply and demand across world oil markets. Until now, oil markets have been dominated by two financial futures instruments: U.S. West Texas Intermediate (WTI) and Europe’s Brent crude. WTI is the main benchmark for U.S. crude grades and a crucial hedging tool for the U.S. oil industry, while Brent, priced off North Sea oil, is the primary value marker for European, Middle Eastern and African crudes. Both are used extensively by industry and financial traders. Asia has so far lacked a financial instrument despite being the world’s biggest and fastest-growing oil consumer. Previous attempts to establish one in Singapore, Japan and Dubai were not widely adopted. Shanghai crude futures may have done the trick if trading volumes this week hold beyond initial enthusiasm. Success in Shanghai would mean the three main global oil markets—Asia/Pacific (APAC), Europe, Middle East and Africa (EMEA), and the Americas—each have a benchmark reflecting their distinct supply and demand drivers. China’s oil demand accounts for more than a quarter of Asian consumption and nearly a tenth globally. "Hopefully, Shanghai crude gets a lot of traction and we end up with three established global benchmarks," said Greg McKenna, chief market strategist at futures brokerage AxiTrader.

One of the main attractions of having globally available crude oil futures is that financial traders can take advantage of regional price differences without investing in physical oil or operating assets such as tankers, oil fields, or refineries. They typically do this through arbitrage trading. Until recently, the primary means of doing this in crude markets was a financial product based on the Brent–WTI price spread. In EMEA, Brent futures are heavily influenced by output policy from the Middle East–dominated Organization of the Petroleum Exporting Countries (OPEC) and by Russia, the world’s biggest oil producer. Since both OPEC and Russia have been withholding production since 2017 to prop up prices, the spread currently reflects a premium that Brent holds over WTI. In the Americas, meanwhile, U.S. oil production has jumped by a quarter since mid-2016 to 10.4 million barrels per day (bpd), further supporting the Brent–WTI gap. Now investors can also trade the arbitrages between China and the rest of the world. It would have been profitable this week, for example, to buy the spread between higher-priced Brent and lower-priced Shanghai by going long the European contract and shorting the Asian contract as the spread widened from $1.60 per barrel on Monday to $4.60 per barrel on Wednesday; closing the positions would have gained an investor $3 per barrel. A spread can be sold as well: had a trader gone short Shanghai and long lower-priced WTI, it would have yielded a gain of $2.80 per barrel, as the gap between the two narrowed from $3.10 per barrel on Monday to just $0.30 on Wednesday. Buying WTI while selling Shanghai would effectively replicate in financial markets the surge in actual U.S. crude exports to China seen in the last two years.

Hedging: crude futures also offer industry participants like oil producers and refiners the chance to protect their assets through hedging. So far, this has been done through the U.S. and European benchmarks. A Chinese refiner importing Middle East crudes—mostly priced off Brent—and needing to protect itself from a sudden jump in prices for those grades would typically buy Brent futures; losses from higher raw material costs can be mitigated by gains in European crude futures. Now the Shanghai contract offers risk-control strategies that better reflect local demand and supply. Should Chinese fuel demand fall and dent the refinery’s sales, that would likely also pull down Shanghai crude futures. A short position in Shanghai futures would profit from a price decline, offsetting at least some of the revenue loss the refiner would incur from its petroleum sales. Oil producers, however, need to protect crude output from falling prices. Thus, a U.S. shale producer selling into Asia could take a short position in Shanghai to hedge against an unexpected drop in demand and prices. Reporting by Henning Gloystein; Editing by Tom Hogue.