Taking a view to the future of chemicals futures markets

28 May 2012 00:00  [Source: ICB]

There is increasing use and influence of petrochemical futures markets in China, especially for LLDPE and PTA

Futures trading in petrochemicals in the key China market is likely to increase incrementally in the coming years as intensifying price volatility enhances the need for risk management, say market players and analysts.


Pic credit: Rex Features

The trend has accelerated in recent times because of factors such as the easy availability of credit and the growth of speculative activity, especially in the trading community.

The co-relation between spot and futures markets in China has historically been very high. In the case of linear low density polyethylene (LLDPE), which is widely traded in China, spot and futures prices are closely interlinked, as buying interest in the spot market tends to weaken when futures prices fall.

"The two prices may not move in the same direction on a daily basis, but the co-relation becomes apparent over a long period," says a market analyst atShanghai CIFCO Futures. A high level of open interest indicates that the LLDPE futures contract is increasingly used by players as a hedging tool rather than for pure speculation, the CIFCO analyst adds.

As many as 303,098 open interest contracts were registered for 2011, up by 53.96% from 2010, according to data from the Dalian Commodity Exchange.

The co-relation is perceived by market players to exceed 90% for a product such as purified terephthalic acid (PTA), where futures prices have a significant impact on the spot market. However, the trend was quite the reverse five years ago, says Kuang Bo, chief PTA analyst with Yongan Futures Broker in China's Zhejiang province.

She says: "In the first two years following the launch of PTA futures on the Zhengzhou Commodity Exchange in December 2006, the spot market led the trend of futures.

"However, with increasing participation by industry players since 2009, PTA futures have started to determine the direction of the spot market."

In the past two years, the trading volume on China's PTA futures has been averaging around 600,000-700,000 tonne/day.

As shown by the chart below, PTA spot prices closely follow the trend in PTA futures for the nearest contract month, while the trend in PTA futures of the most actively traded contract month usually forecasts the ups and downs in spot prices.

Prices of methanol spot cargoes have also been following futures market trends.

Volumes traded on the Zhengzhou Commodity Exchange vary from 50,000-200,000 tonne/day.

Although the futures market for polyvinyl chloride (PVC) in China is not as large as that for LLDPE or PTA or methanol (the daily traded volumes total only around 100,000 tonne), an increasing number of PVC producers and traders are starting to use futures trading to hedge their positions in the spot market.

Macroeconomic factors and changes in government policy can have a sharp impact on futures prices. For example, the sharp upturn in PVC futures prices in the fourth quarter of 2010 was because of the energy saving and emission reduction policy, while the sharp downturn in prices in September 2011 was triggered by concerns over the slow recovery of the US economy and the EU debt crisis, says a Shanghai-based market analyst.

It was a similar story with PTA futures. But both PVC and PTA futures bounced back a little by the end of November 2011 thanks to the easing of the Chinese government's monetary policy. And in the case of PTA, production cutbacks further bolstered futures prices late in quarter four 2011.

Macroeconomic factors such as interest rates, crude oil prices and stock exchange index fluctuations tend to also impact methanol futures trends. Methanol futures prices tend to rise in tandem with crude and tumble when crude softens.

In the case of LLDPE too, crude futures, credit liquidity, stock markets in and outside China, US and Chinese monetary policies can deeply affect futures prices, while demand-supply fundamentals in the spot market have a longer-term impact on futures trends.

On a daily or weekly basis, futures trades for LLDPE can be disconnected from the spot market fundamentals, and tend to be influenced more by financial and economic news such as government policies on the property market or credit liquidity.

The disconnect between spot and futures LLDPE prices deters Chinese PE producers from pricing their physical cargoes based on futures prices, bucking the trend in more mature markets such as copper futures, where producers price their spot cargoes based on futures prices, says the CIFCO analyst.

In the case of players along the PTA-polyester supply chain, the trend is somewhat different. "PTA and polyester players, especially buyers (in the polyester fiber and textile segments), monitor closely the trend in the futures market to decide the best purchasing time and purchasing volumes.

"They tend to buy more PTA and polyester when PTA futures trend higher and buy less when PTA futures trend lower," says Kuang Bo.

The key use of futures contracts, however, is less about pricing spot physical against front-month futures, and more about the term structure of the forward curve, says Matthew Sullivan, director, energy solutions sales, with HSBC.

"For instance, the PTA curve is in backwardation, implying tight supply and an economic signal for participants to a) produce, and b) draw inventories down; while the LLDPE curve is in contango, implying adequate supply and an economic signal to a) limit production to the most efficient facilities, and b) store volume for a carry trade if the cost of carry is less than the annualized difference between spot purchases and forward futures sales," says Sullivan.

How will the increasing influence of the futures market affect spot pricing benchmarks? "In my view, there is room for both - but (pricing information services) would need to match the liquidity of the futures market in terms of the number of participants they survey versus the number of active traders in front-month futures in order to qualify as completely relevant benchmarks," Sullivan adds.

Chow Bee Lin, Becky Zhang, Maggie Zhu and Heng Hui contributed to this article. This is an update of an article that first appeared in the APIC 2012 Supplement prepared by The Chemical Daily and ICIS on behalf of this year's APIC organizer Malaysian Petrochemical Association

By: Prema Viswanathan
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