Japan's first crude futures contract faces cool reception

Japan's first-ever crude futures contract will debut on the Tokyo Commodity Exchange's (TOCOM) on September 10 after a delay of more than three months and to a lukewarm reception from physical traders, industry sources said yesterday.

"We will not participate in the new futures contract at least for a while because the contract is not really designed for physical traders like ourselves," said an official at Idemitsu Kosan Co Ltd, Japan's second-largest oil refiner in terms of domestic sales.

TOCOM, Japan's largest commodity futures exchange, will list the yen-based crude futures contract, based on an average of Oman and Dubai crudes, the most liquid Middle Eastern physical crudes in the Asian spot market.

Idemitsu was the only Japanese refiner that took part in TOCOM's preparatory committee, but it withdrew after the exchange declined to listen to its suggestion that the contract be based in U.S. dollars, the dominant currency in global oil markets.

The Idemitsu official said the currency exchange risks inherent in a yen-based contract would make it difficult for them and other refiners to trade in TOCOM's crude contract. TOCOM Chairman Tadayoshi Nakazawa said this month the exchange hoped to respond to the large potential need for risk hedging in Asia.

Japanese industry sources say, however, that it is a conservative industry and they see little immediate demand to hedge purchases since the bulk of their crudes comes from the Middle East and set on a formula based on Oman and Dubai. There will be no physical delivery of the contract, and industry sources say this is an additional factor that makes the instrument inappropriate.

Settlement will be in cash and based on six published assessments - Reuters, Bloomberg, Petroleum Argus, RIM Intelligence, Telerate and London Oil Reports (LOR) for the Oman and Dubai grades. "Without physical delivery, it may be hard to use the contract as a hedging tool," a commodity broker said.

TOCOM also set tight regulations so the contract would not be a target of the speculative trading seen in palladium futures last year, but this was an additional factor likely to curb participation by physical traders, sources said.

In February 2000, TOCOM froze palladium futures contracts and banned physical deliveries and new positions after they soared on speculation and a shortage of the metal. Japan's Trade Ministry had delayed granting approval for the oil contract because of concerns about risk management in the market following TOCOM's intervention in the palladium futures.

To avert a repetition and to hasten approval from the Trade Ministry, TOCOM set position limits for investors in the spot month at a maximum of 160 lots, which is equivalent of 100,640 barrels. One lot is 100 kilolitre (kl).

That is a very small volume compared with the 500,000-barrel cargo that is typically traded for an Oman crude, and makes the TOCOM contract even more unattractive, traders say.
Yet the new crude contract might see interest from individual investors if futures prices become volatile.

TOCOM's launch two years ago of kerosene and gasoline futures contracts enjoyed robust volume, and this encouraged it to consider listing crude oil futures. Individual investors still account for nearly 90 per cent of turnover on Japan's commodity futures, compared with about 30 to 40 per cent in the United States.

Despite a rise in the number of commodities listed on TOCOM, private investors tend to trade the most volatile contracts. TOCOM's Nakazawa has said he was not worried about the past lack of success in crude futures contracts in Asia.

He said he was confident arbitrage trading between TOCOM oil product futures and the new crude contract will pick up given the ample liquidity of TOCOM's product futures. In May last year, the New York Mercantile Exchange (NYMEX) launched a similar Middle East sour crude contract, also based on the average of Oman and Dubai, but it has been unsuccessful.

"The most important thing in the new crude contract will be to create high liquidity in the market to attract interest, particularly from individual investors," a TOCOM spokesman said.