A Long Road to Listing
On December 10, 2018, after six years of preparation since 2013, the Dalian Commodity Exchange (DCE) finally launched the monoethylene glycol (MEG) futures in China. DCE had first officially released its plan to list the MEG futures in 2016. During the listing process, DCE experienced opposition from polyester producers for many reasons.
Polyester producers opposed the listing of MEG futures due to two major factors:
- First, they were worried that coal-based MEG, which is mostly produced in China due to cost and natural resource constraints but typically has lower qualities, could pass DCE’s delivery standards to participate in the delivery through technical manipulations, thereby seriously impacting producers’ business operations.
- Second, the futures of another important raw material to them, purified terephthalic acid (PTA), had already been listed, and therefore the listing of MEG could potentially add complexity to the market and increase price risks.
The first point turned out to be a miscommunication between DCE and polyester producers, as DCE later made it clear that its MEG delivery quality standards would prevent coal-based MEG from being mixed into delivery. For the second point, as time went by, polyester producers became more skilled in using various hedging tools on other raw materials, and therefore changed their attitudes toward the MEG futures and started looking at this as a useful tool for risk management.
As-Is Pricing Model
Downstream applications of MEG are highly concentrated in China, as up to 93 percent of the total volume goes to the polyester industry. Also, as the market share of MEG has been highly concentrated, with only a few large manufacturers (top five manufacturers are SABIC, DOW, Sinopec, FPG and SHELL, who account for about 55 percent of the total capacity worldwide), and because imported MEG accounts for nearly 60 percent of the total demand in China — pricing used to be dominated by these large players. Sales of MEG mainly went directly through manufacturers to downstream polyester producers. Spot sales via open markets were not commonly observed.
Purchasing pricings were usually settled monthly. The common practice for price settlement was sellers providing quotes at the beginning of each month, then referring to the monthly average price for adjustment, or by simply adopting the market monthly average price, depending on agreements with buyers. ICIS average prices, Platts average prices, Sinopec settlement prices and CCF average prices were the four major sources for price references.
It is worth noticing that long before the listing of MEG futures, a semi-futures pricing model was already observed in the market. In addition to spot trading, market participants leveraged multiple financial tools, such as “paper goods” (contracts that are essentially like futures), swaps and the Huaxi online trading center.
Impact on the Current Pricing Model
The development path of the PTA industry since the listing of PTA futures could be an important reference for the MEG industry, as both PTA and MEG are heavily purchased by the polyester industry, and polyester producers are mostly involved in the PTA futures trading for a considerable period.
Two possible changes in the current pricing model could be expected upon the listing of MEG futures:
First, a closer linkage between MEG futures and the spot market might be seen, as the market gradually moves to a “futures price + premiums and discounts” pricing model.
Second, basis trading would become more prevalent. In China, for other import-dependent commodities whose futures are listed — such as soybeans, polyolefin and PTA — throughout the years market participants have developed a pricing model that is essentially the combination of basis trading and options. Specifically, buyers and sellers agree on a certain quotation period (typically, the time required for shipment); within the period, one side (more often the buyer side in the case of China) has the option to select the futures price of a certain day as the basis price. Both sides use futures to make necessary hedges. As this model is effective against risks during shipments, given that MEG prices are relatively volatile, this model is expected to be more widely adopted.
Impact on Price Analysis Framework
Major factors affecting MEG prices include the macro environment, supply & demand, production cost, sales profitability and inventory level. The listing of MEG futures could mainly bring about two aspects of influence:
First, price relationships between MEG and PTA could be redefined. Being complementary goods, MEG and PTA have been showing continuous consistency in price movements. PTA was more often used as a hedging tool by industrial funds that usually held short positions on futures, while MEG, without a unified futures market, was more exposed to market speculations; investors, therefore, often held long positions. The listing of MEG futures, however, could possibly change the trading logic for both products; therefore, a revisit of price relationships could be necessary.
Second, the macro environment would have a greater influence on the MEG market. Also, in addition to fact-based analysis, market expectations should be paid more attention to as financial attributes of the MDG market are reinforced upon the listing of futures.