China and Russia Looking to Drop US Dollar for Oil Payments

yuan-vs-dollarJust days after Beijing officially launched Yuan-denominated crude oil futures (which are expected to quickly become the third global price benchmark along Brent and WTI), Reuters reports China has taken the next major step in the challenging the US dollar’s supremacy as global reserve currency (and internationalising the Yuan) by paying for crude oil imports in its own currency instead of US dollars.

A pilot program for yuan payment could be launched as soon as the second half of the year and regulators have already asked some financial institutions to “prepare for pricing crude imports in the yuan”, Reuters sources reveal.

According to the proposed plan, Beijing would start with purchases from Russia and Angola, two nations which, like China, are keen to break the dollar’s global dominance. They are also two of the top suppliers of crude oil to China, along with Saudi Arabia.

A change in the default crude oil transactional currency – which for decades has been the “petrodollar”, blessing the US with global reserve currency status – would have monumental consequences for capital allocations and trade flows, not to mention geopolitics. As Reuters notes, a shift in just a small part of global oil trade into the yuan is potentially huge. “Oil is the world’s most traded commodity, with an annual trade value of around $14 trillion, roughly equivalent to China’s gross domestic product last year.” Currently, virtually all global crude oil trading is in dollars, barring an estimated 1 per cent in other currencies. This is the basis of US dominance in the world economy.

However, as shown in the chart below which follows the first few days of Chinese oil futures trading, this status quo may be changing fast.

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The danger, of course, is that such a shift would also boost the value of the Yuan, hardly what China needs considering it was just two a half years ago that Beijing launched a controversial Yuan devaluation to boost its exports and economy.

Still, in light of the relative global economic stability, Beijing may be willing to take the gamble on a stronger Yuan if it means greater geopolitical clout and further acceptance of the renminbi.

1522702615-py5Which is why restructuring oil fund flows may be the best first step: as of this moment, China is the world’s second-largest oil consumer and in 2017 overtook the United States as the biggest importer of crude oil; its demand is a key determinant of global oil prices.

If China’s plan to push the petroyuan’s acceptance proves successful, it will result in greater momentum across all commodities, and could trigger the shift of other product payments to the yuan, including metals and mining raw materials.

Besides the potential of giving China more power over global oil prices, “this will help the Chinese government in its efforts to internationalise yuan,” said Sushant Gupta, research director at energy consultancy Wood Mackenzie. Last week, Goldman Sachs said that the success of Shanghai’s crude futures was “indirectly promoting the use of the Chinese currency”. (However, as noted above, this has negative tradeoffs as it would also result in a stronger Yuan, something the PBOC may not be too excited about).

The bottom line here is whether Beijing is indeed prepared and ready to challenge the US dollar for the title of global currency hegemony. As Reuters notes, China’s plan to use yuan to pay for oil comes amid a more than year-long gradual strengthening of the currency, which looks set to post a fifth straight quarterly gain, its longest winning streak since 2013.

Meanwhile, Russia is also considering replacing the US dollar in crude oil payments on deals with Turkey and Iran, Energy Minister Alexander Novak said as quoted by RT.

According to Novak, “There is a common understanding that we need to move towards the use of national currencies in our settlements. There is a need for this, as well as the wish of the parties. This concerns both Turkey and Iran – we are considering an option of payment in national currencies with them. This requires certain adjustments in the financial, economic and banking sectors.”

Iran, under threat of returning US sanctions, two months ago decided to ditch the US dollar as a currency in its imports. The argument in defence of the move was that Iran has no access to dollar transactions because of the sanctions, and removing it as an import payment currency would make life easier all around.

The advent of cryptocurrencies could facilitate the move away from the dollar as an international oil trade settlement currency, one analyst said recently. In a December 2017 note, Stephen Brennock from PVM Oil Associates said cryptos could help commodity-producing countries to switch from dollar to cryptocurrencies to reduce their dependence on the US dollar. At the same time, he said, it would curb their exposure to dollar movement risks and the effects of sanctions, which typically feature cutting off access of the target country to international funding.

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