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2015-07-03 10:02:56
How China continues to reshape the world of commodities
Jul 4th 2015
THE world s biggest consumer of commodities is no longer just an insatiable
buyer of everything from coal to gold. A richer, slower-growing and choosier
China is becoming an exporter as well as importer. It is also using its clout
to change the way commodities are traded, bringing markets closer to home and
drawing up rules that suit its needs instead of those of producers and Western
financiers.
This week, for example, Chinese regulators gave the go-ahead for foreigners to
trade crude-oil futures in Shanghai. When that starts probably by November it
will be the first time that outsiders have been allowed to buy and sell a
listed Chinese futures contract. This is part of a clear plan to change the way
commodities are traded, says Owain Johnson of the Dubai Mercantile Exchange
(DME). The exchange in Dalian, a port through which many commodities enter
China, has become the biggest trading centre for iron ore in the world in less
than two years. Shanghai has developed big markets in nickel and copper.
Many expect more gold trading to move to China too. Allegations of rigging have
rocked the current hub, in London. China the world s largest producer of
bullion announced on June 26th that it would launch a yuan-denominated gold
contract in Shanghai by the end of the year. China is reaching critical mass
in its influence on commodity prices, says Grant Sporre of Deutsche Bank.
This is a much more sophisticated way of wielding clout than in the past. An
attempt by China in 2010 to corner the market in rare earths 17 exotic metals
used in tiny quantities in many modern devices failed spectacularly. China,
which at the time produced 97% of the ores for rare earths, banned exports in
the hope of bringing the business of processing these deposits onshore. But
rare earths proved not so rare: companies elsewhere revived old mines and
ramped up production; by late 2011 prices had plunged.
The goal now is to seize control of price formation. The main global benchmark
for crude oil, Brent, relies on data compiled by price-reporting agencies about
deals done during a short window in the middle of the trading day.
State-controlled Chinese oil companies have been playing an increasingly active
role in that process, but from the Chinese government s point of view, bringing
the trading closer cuts costs and reduces the impact of events in faraway
places from which the country imports little oil. They ask: Why should a
Norwegian oil workers strike affect our economy? says Mr Johnson.
As the world s biggest importer, China wants its own benchmark instead, based
on transparent and comprehensive data, priced in its own currency and governed
by its own laws. The Shanghai oil-futures contract aims to achieve that goal.
As exchanges in mainland China grow, rivals are feeling the squeeze. The
Shanghai Futures Exchange is impeding efforts by Hong Kong Exchanges and
Clearing to expand its metals-trading business, following the acquisition of
the London Metal Exchange in 2012. In March the Shanghai exchange threatened to
sue its Singaporean counterpart for copying a futures contract.
Several obstacles lie ahead, however. Outsiders will not be keen to bear the
exchange-rate risk of trades denominated in yuan. The security of the English
legal system in case of disputes will be hard to match. Confidence has been
dented by a scandal involving Chinese commodity warehouses, in which metals
were used as collateral for letters of credit to get around foreign-exchange
restrictions.
China is putting a fresh imprint on commodity markets in other ways too. As its
economy slows and investment gives way to consumption as the mainstay of
growth, the country s needs are changing. Demand for primary products used
mainly in housing and infrastructure coal, iron ore, steel and aluminium is
slowing. China has already hit peak coal (consumption is falling, amid
worries about air pollution); peak steel is not far off, with growth of only
1-3% likely after a dip last year. Even copper is fading a bit. Consumption
used to grow faster than GDP, notes Colin Hamilton of Macquarie, a bank; now it
lags. A related headache is that China, once a sponge for raw materials, is
becoming an exporter of things like stainless steel and aluminium, thanks to
cheap and abundant power, growing technological nous and a glut of smelting
capacity.
Instead, exporters must look to other commodities for growth. Richer Chinese
consumers are stoking demand for dairy products, meat, chocolate and jewellery.
That has an effect both on those items directly and on the commodities used to
produce them. While imports of iron ore wane, for example, demand for
soyabeans, which are used mainly to feed livestock, continues to grow rapidly
(see chart). That is partly because China has paved over lots of soya farms,
but mainly because meat consumption is up.
Yet it is not certain that this trend will persist. The average Chinese already
consumes more calories than the global average, and almost 85% of the American
level. A healthy switch from pork to chicken would actually cut demand for
agricultural commodities, notes Capital Economics, a consultancy. Hershey, a
big confectionery company, has had to trim its forecasts for sales growth in
China.
Whether China adopts old Western habits or opts for thriftier and healthier
ones will shape the commodities industry. But its impact on trading is even
more immediate. As every good capitalist knows, the customer is always right.
China is using its buyer s clout to ensure that commodities are traded the way
it wants.