* Derivatives link to physical trading gets stronger
* As U.S. oil output rises, Asia expands refining capacity
* Asian subsidy cuts also trigger rising volumes
By Jessica Jaganathan
SINGAPORE, Dec 17 (Reuters) - Asia's growing oil product flows, tied to massive new refinery investments, are driving a big rise in derivatives trading in the region with volumes for diesel, jet fuel and gasoline are all set to rise sharply this year.
Refining capacity in China rose by almost 900,000 barrels per day (bpd) between 2012 and 2013 to 13 million bpd, according to the U.S. Energy Information Administration, and capacity in the Middle East is also up.
Indonesia, one of Asia's top oil importers, is also planning huge expansions of refining and storage.
"More product trading is becoming more long-haul and this can be seen via National Oil Companies (NOCs) trying to build up downstream operations to produce clean refined products," said Mike Davis, director of ICE Futures Europe's market development, referring to products such as diesel and gasoline.
"By diversifying from just exporting crude, NOCs are developing their operations and institutions in China, India, Middle East and elsewhere to balance their assets and liability bases," he added.
Singapore gasoline showed the most growth, reaching 5.675 million barrels over January to November this year in Platts' window of trading hours, up from 600,000 for the whole of 2012, and from 2.675 million barrels in 2013, a Platts spokesman said.
Singapore diesel and jet fuel volumes have risen to 251.6 million barrels over January to November this year, up about 40 percent from 2013, and up nearly 70 percent from 2013, he added.
The shifting fundamentals are accompanied by changing market participants.
While banks have scaled back commodity derivatives trading due to regulatory uncertainty, NOCs are stepping in.
Saudi Aramco, for instance, traded its first diesel and fuel oil derivatives in pricing agency Platts' monitored trading hours in September and October.
Others, including China's Sinopec and CNPC, have significantly increased their trading arms too.
Gasoline volumes have also been boosted by soaring U.S. shale oil production which has entered the market and contributed to a 45 percent drop in oil prices since June.
"Arbitrage on both sides of the Atlantic, as well as Asian-European arbitrage has surged. On (diesel), there are physical exports pouring into Europe from the States, Middle East, India and other places," Davis said.
Removal of oil subsidies in countries like India, Indonesia and Malaysia could boost products volumes further, experts said.
"One of the reasons derivatives volumes have (so far) been lower out of Asia is that people lack a reason to hedge as often the product you're selling is regulated by the government," said Alan Bannister, Executive Director for Asian energy products at CME Group, noting this was now changing. (Additional reporting by Florence Tan; Editing by Henning Gloystein and Ed Davies)