a Nurtures Futures Markets in Bid to Sway Commodity Prices

By JAMES T. AREDDY ZHENGZHOU, China -- Chinese leaders are concerned that their nation's enormous economic expansion is becoming an excuse for foreign suppliers to inflate commodity costs. So, they hope to use their three futures exchanges to fight back. Government officials say the country is positioning its futures markets to be major players in setting world prices for metal, energy and farm commodities. By letting the world know how much its companies and investors think goods are worth, China hopes to be less at the mercy of markets elsewhere. "It is true we have a long-term goal of increasing our influence in terms of pricing, but to do that we have to create conditions and do it step by step," Jiang Yang, chief futures-industry policy maker and assistant chairman of the China Securities Regulatory Commission, said in an interview. "But as the Westerners say: 'Rome was not built in a day.'" Now in China's scopes: the $130 billion it spent importing oil last year. Globally, crude oil is the biggest and most important traded commodity, and China is the second-largest importer after the U.S. The New York Mercantile Exchange's contract for light, sweet oil -- a grade of crude easily refined into gasoline -- is the world's most actively traded one and is thus the dominant mechanism for setting the global price. But as early as next year, the Shanghai Futures Exchange may muscle in with its own contract in crude oil, possibly modeled on New York's global benchmark, according to people familiar with the situation. That would, for the first time, give Chinese traders a direct role in valuing the commodity. "We are actively thinking about crude oil now," says one of the people involved in the planning. The emergence of major stock, bond and commodity markets in nominally communist China is one of the starkest examples of the nation's embrace of capitalism. As China marks the 60th anniversary of the founding of the People's Republic this month, the nation is celebrating its rise as an economic superpower. Beijing is increasingly eager to assert its clout -- challenging international policy makers to rethink the global currency system, how multilateral institutions are run and the direction of global trade talks. To be sure, China's fledgling futures markets don't pose any immediate threat to the giant exchanges in New York, Chicago and London that set benchmark prices for most commodities. For one thing, the Chinese challengers are largely closed to foreigners, and government-owned entities are among the biggest traders -- hardly a recipe for a freewheeling global marketplace. At most, the emergence of big futures exchanges in China is giving Chinese companies and speculators a role, but not control, in determining global costs alongside traders in the West. But Beijing believes hosting big futures markets will enhance the country's economic security by essentially advertising what the world's biggest customer for some commodities considers a fair price. For the rest of the world, the exchanges could mean less guesswork about China's buying habits, possibly reducing volatility in the global market. Already, copper and soybean suppliers shift output toward or away from China depending on how its futures prices are moving. Increasingly, traders say, Chinese futures appear to drive price trends elsewhere, particularly in metals like copper. An expanding list of 21 commodities traded on China's exchanges includes many of the goods imported in vast quantities by the world's fastest-growing major economy. China buys 10% of all crude oil, 30% of copper output and 53% of the world's soybeans, according to Barclays Capital. American consumers are already feeling China's buying power in commodities. In 2007 and 2008, markets were gripped by a belief that surging car ownership in China and other developing countries was destined to drive crude oil ever higher. That thinking helped send oil futures soaring in New York to a peak of $147 a barrel in July 2008. American drivers saw the average price of gasoline rise 85% between late 2006 and July 2008. Then, worries about global recession pushed gasoline prices almost two-thirds lower last year. Early this year, traders determined that China was stocking up on crude -- and oil prices have rebounded 61% so far this year. Futures are exchange-traded contracts that fix a price to buy or sell sugar, copper or oil a day, month or year in advance. Basic food, energy and raw-material costs are determined on commodity-futures exchanges, affecting everything from the sticker price of automobiles to the cost of gasoline at the pump and a hamburger at a drive-through window. Chinese historians claim the country originated a version of grain futures contracts some 800 years ago, during the Song Dynasty. Modern-style futures trading began almost 160 years ago in Chicago with corn. In the early 1990s, China was eager to demonstrate its embrace of market economics and launched stock and commodity-futures trading. But there wasn't much planning. More than 50 commodity exchanges sprang up, many of them trading primarily lu dou, or green mung beans, a variety that after soaking stretch into crunchy white sprouts. Mung-bean prices made little difference to China's economy but proved wildly popular with speculators, until a 1995 futures scandal prompted regulators to close all but three exchanges. Beijing overhauled futures trading after it joined the World Trade Organization in 2001. It fused markets onto the real economy with cotton, soybean, copper and rubber trading, but eschewed the exotic financial derivatives tied to stocks, bonds and currencies that were gaining in popularity in the U.S. For China, it was also a time of soaring commodity imports -- which fostered suspicion about foreign merchants. In 2002, Beijing hit foreign soybean suppliers like Minnesota-based Cargill Inc. with import restrictions. It also modernized the Dalian Commodity Exchange's soybean-futures platform. The result today: The northeastern China exchange's soybean prices are tracked almost as closely as the global benchmark in Chicago. "It's not a local exchange anymore, it's a big exchange," says Robert Horster, a Cargill risk manager. During the weeks Cargill soybean cargos are steaming toward China, Mr. Horster's Shanghai-based team uses Dalian futures to insure, or hedge, against gyrating prices -- and to make money on price differences between Dalian and Chicago, in trades called arbitrage. Chinese futures are attracting institutional investors like Rockwell Investment & Holdings, a Ningbo-based firm with a dozen analysts and traders. It is run by Ye Qingjun, who first put money into China's futures markets in the early 1990s as a copper-company official eager to apply what he was learning about supply and demand. But Mr. Ye says those early days were "messy," with prices of silk, plywood and other products listed on blackboards and jostled by arbitrary rule changes. During a violent swing in mung beans, Mr. Ye got wiped out. Today, the 42-year-old says the industry is more professional and complex, driven as much by Chinese import trends as swings in the U.S. dollar. Facing five computer screens that flicker commodity, stock and currency prices from Shanghai to Chicago, Mr. Ye says futures are now tied to the real world and "related to the scale of China's economy and the pace of development." The 165 million contracts in white sugar that changed hands on the Zhengzhou Commodity Exchange last year made it the most-active commodity future anywhere, according to the Washington-based Futures Industry Association. In 2008, Chinese exchanges traded three of the world's five most-active metals contracts and seven of the 10 biggest agricultural contracts based on volume, the group says. World financial markets are on constant alert for changing trends in China's economy. Shanghai's big stock market is sometimes regarded as an economic barometer for China, though futures may provide deeper insight, since commodities actually change hands when contracts expire. China has turned to futures markets to augment its sometimes rocky global commodity scramble. Beijing is flexing new diplomatic muscle in the Middle East and sending its navy to patrol strategic shipping lanes. It has locked in supplies with infrastructure-for-oil deals in Angola, copper-mine purchases in Peru and cultivation of farmland in Australia. In addition to oil, China is developing futures contracts in tin, lead, silver and pork. Another Chinese futures contract could transform global container-shipping rates, which officials believe have gotten so volatile that exports are being held back, says a person involved in the effort. The regulator, Mr. Jiang, said futures may assure Chinese commodity importers "get fairer deals." Before the Shanghai Futures Exchange launched fuel-oil futures in 2004, he said, the benchmark Singapore price would soar when empty Chinese ships arrived in the harbor there looking to load up with fuel oil they would transport back home; the price would then drop once they sailed away. Now, predatory pricing practices don't work as well, Mr. Jiang said, because China's fuel oil buyers can insist on terms that reflect Shanghai futures levels. "So that gave them very strong bargaining power," he said in the interview. As Chinese futures trading pumps up global volumes, exchanges like CME Group Inc.'s New York Mercantile Exchange and Chicago Board of Trade are tilting eastward. To better reflect trading in soybeans and other agricultural products during Asian hours, CME recently tacked 75 minutes onto its busy overnight session, making it 13 hours and 15 minutes long. Volumes promptly rose 65%. To offer clients access to China's markets, J.P. Morgan Chase & Co. has located brokers near Guangzhou. "It's got such huge pricing power in commodities it is able to influence physical prices, which gets reflected in futures prices," says Richard Shen, who directs the operation. Futures exchanges won't solve key commodity challenges for China, including the government's charge that steelmakers overpay to import iron ore. That mineral cost China $60.53 billion last year. But it isn't traded on exchanges and is instead priced in negotiations with major suppliers, which may result in higher profits for suppliers. Some caution that high volumes on Chinese exchanges overstate their importance. A futures industry joke says China is second only to the weather in driving some commodity prices -- but less predictable. Even Zhengzhou exchange officials concede frenzied sugar trading may signify speculation among the country's 300,000 active futures investors more than China's sweet tooth. For every Chinese contract like copper or soybeans that cleanly reflects China's actual needs, professionals say there is another like sugar or corn with a loose -- or "dirty" -- relation to on-the-ground fundamentals. International futures-market benchmarking has been slow to shift to China from long-established exchanges like the New York and Chicago venues. Despite China's huge volumes, its futures markets allow foreigners limited access. By contrast, the London Metal Exchange says 95% of its business emanates from overseas. General Motors Co., Ford Motor Co. and Tyson Foods Inc. are some of the companies that use futures in the U.S. to protect themselves from volatility in commodity prices. Despite expanding production in China, and being technically eligible to hedge on China's exchanges, all three say they haven't used its futures markets. Instead, the big footprints in China's futures markets belong to state-owned groups, primarily commodity trader Cofco Corp. and Beijing's secretive stockpiling agent, the State Bureau of Material Reserve. That makes the government both player and policy maker. —Bai Lin and Ellen Zhu in Shanghai contributed to this article. Write to James T. Areddy at james.areddy@wsj.com