China will join the race for a global steel benchmark with its first major steel futures contract on Friday, but it will need to thread a fine line to woo both local speculators and big mills.

The fact that the contract is located in the world's biggest steel producer and consumer is both a blessing and curse for the Shanghai Futures Exchange: while there is no shortage of small trading houses eager to trade, there is also the risk of rampant speculation, the kind that sank a previous contract in the 1990s.

The Shanghai bourse has already found local success with copper and other commodity futures that have had a growing influence on global markets, and it may face better odds with steel, which has yet to gather critical mass on any of the four exchanges that launched contracts over the past few years.

"We have not yet had a global pricing centre for steel products, and the futures in Shanghai can play the role," said Tan Wentao, head of research and development at Shanghai-based HNA Topwin Futures.

"China is a country with a mature steel industry and great growth potential, because it has many steel firms in different provinces, which would lend weight to a national, even a global, benchmark," he said.

The move also comes as global steel mills are relaxing their resistance to steel futures first seen as a threat to their pricing power. With steel prices having collapsed amid a global recession, the allure of managing price risks has risen.

At the same time, China's nearly $600 billion fiscal spending is expected to translate into a substantial recovery in domestic steel demand, a factor that could give an incentive to end-users to lock in lower prices today.

The Shanghai Futures Exchange will start trading reinforcing steel bar and wire rod on Friday. The two products account for more than 30 percent of 500 million tons of annual steel output in China, which churns out more than one-third of global production.

The contracts are being launched 15 years after the regulator forced a halt to steel futures trade that had begun in Suzhou in 1992. This had fed a flurry of speculation and the creation of the so-called "Zhejiang Gang" farmers and merchants, who had grown wealthy trading in financial derivatives and real estate.

Success elusive

There are strong headwinds, however, to grow as a global benchmark, as four exchanges which already launched steel trading are struggling with thin turnover.

The total turnover on the two steel contracts offered by London Metal Exchange, the international benchmark setter for copper, aluminum and other base metals, has reached only 1.3 million tons since trading began a year ago. On some days there is no trade at all.

And in China, the contract is emerging after years of opposition by the China Iron and Steel Association, which fears financial speculators may distort already volatile prices.

Officials in private-sector steelmaker Jiangsu Shagang and State-owned Shougang, the country's two largest reinforcing bar producers, said they had no detailed plans for futures trading, although their products are registered brands for the futures settlement.

China's move to discourage State-owned enterprises from investing in financial derivatives after some of them reported huge losses from such trading may also dampen liquidity.

But with 170,000 small-scale steel trading firms in China alone, there should be no shortage of participants. Tan says he expects trading houses to make up 60-70 percent of the market.

"Steel futures is a relatively volatile business ... and small firms are more interested in the (futures) business as they have a more flexible operational structure than big steel mills," said Kuang Bo, deputy general manager at Guangdong-based Asia Steel, a scrap metals manufacturer and wholesaler.