China is increasing its reliance on oil from the Middle East, with imports from the region growing in Q1 2022. That has accelerated the need for reliable sour crude futures contracts.
The Covid pandemic and its associated impact on economic growth has triggered a prolonged period of oil price volatility. While oil prices were on a broad upward trajectory in 2021, price swings continued to be a feature of the market in the face of the ongoing uncertainty created by the pandemic.
For example, the price of West Texas Intermediate (WTI) plummeted from $78 per barrel to below $65 per barrel following the emergence of the Omicron variant in late November 2021. It then touched $130 per barrel in March 2022 on geopolitical events in Europe as China continues to see major COVID-related lockdowns.
A Growing Appetite for Oil Futures
This period of oil price volatility coincides with the growing demand for derivatives among individuals and businesses in Asia, particularly in China. Market participants are utilizing future commodity prices to manage price volatility and foreign exchange risk. The total number of futures and options traded on exchanges in the Asia Pacific soared 51.6% year-over-year in 2021, the largest increase recorded for any region, according to the Futures Industry Association (FIA).
Increased Reliance on Middle East Oil Imports
Despite the ongoing disruption caused by the pandemic, and the impact of lockdowns on economic activities, oil demand in China has remained strong. Demand was 7.39% higher in 2021 compared with 2020, compared to an increase of 4.69% in Europe during the same period, according to OPEC’s Monthly Oil Market Report.
OPEC expects demand in China to remain robust this year, even with current city lockdowns, predicting an increase in consumption of 0.66 million barrels per day (mb/d) in 2022 on the back of steady economic growth, and increased demand from the transport and industrial sectors. Other Asian countries, excluding India, are not far behind, with OPEC penciling in a 0.55 mb/d increase in demand in its February report, representing a jump of just over 6%.
Only some of this rise in demand will be met domestically, with the rest made up through imports. China is becoming increasingly reliant on oil imports from the Middle East, with imports from the region rising 4.8% during the first quarter of 2022, to account for 53.8% of China’s crude oil supplies. Saudi Arabia was China’s top crude oil supplier, while Russia was in second place, despite a 14.1% fall in imports, with Iraq third and Oman the fourth largest supplier. Overall, imports from Oman were up 4.7% during the first quarter, compared with the same period of 2021.
While China is by far the largest importer of Oman crude, accounting for 86% of its exports, according to its Statistical Year Book 2021, all of Oman’s top oil export destinations are in Asia; India lands in second place, followed by South Korea and Japan.
As geopolitical events continue in Europe, it is yet to be seen how Russian exports will impact the Middle East flows.
The Rise of Oman Crude Oil
Asia’s growing reliance on Middle East crude, combined with the futurization of oil markets, has accelerated the need for reliable sour crude futures contracts. Oman has enjoyed political stability over the past several decades, enabling it to increase both its production and exports of crude oil. During this time, Oman crude oil has also established itself as a benchmark grade for the Middle East and Asian markets.
The Dubai Mercantile Exchange (DME), in which CME Group holds a 50% stake, was founded in 2006 and launched its flagship Oman Crude Oil Futures Contract in 2007 to provide a transparent crude oil benchmark for the region. In the same year, Oman adopted the DME price as its official selling price, with the Dubai government later following suit. More recently, in 2018 and 2019, the national oil companies of Saudi Arabia, Bahrain, and Kuwait added DME Oman to their pricing formulas on the back of its steady trading volumes and use by international players.
As a result, Oman crude has become an important part of the pricing structure for 5.5 million barrels of crude exported daily from the Middle East to Asia.
DME Oman futures pricing is also an integral part of the Chinese Retail Fuel Price crude basket utilized by the Chinese National Development and Reform Commission, alongside WTI and Brent, to measure Chinese Gasoline and Gasoil prices. This component part further enhances DME Oman Crude futures’ status as an important hedging tool for the Asia market, particularly the end users whose refining margins are directly impacted by changes in such prices.
The DME Oman Crude Oil futures contract remains the world’s only sour physical-delivery crude oil futures contract, making it an important hedging tool for companies with Middle East oil exposure and for speculative global oil traders.
Oman crude has been the de facto sour crude benchmark for exports to the East of Suez for a number of years and the creation of DME Oman futures pricing has increased the transparency and relevance for Asia. DME Oman is now a vital benchmark pricing tool to measure the global crude flow alongside other global crude benchmarks such as WTI and Brent.
Weathering the Pandemic
DME Oman faced a stiff stress test in 2020 when global oil demand dropped by up to 30%, as the Covid pandemic put the brakes on economic activity. However, the contract was able to weather the unprecedented volatility, a fact that was recognized by market participants. Relative to other pricing points, the DME Oman contract also reflected market fundamentals throughout the pandemic, while maintaining liquidity and stability. This enabled it to emerge as a stronger benchmark.
Oil price volatility is expected to continue in 2022 due to a combination of supply concerns, difficulties in predicting demand due to the ongoing pandemic situation, and rising interest rates as central banks look to tame inflation, which could lead to a strengthening U.S. dollar.
As a result, the need for hedging strategies among oil consumers is likely to increase. DME Oman Crude Oil futures contracts are an effective risk mitigation tool for Asia, given its dependence on Middle East oil imports.
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This story was originally published September 19, 2022 7:00 AM.
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