The end of the dollar hegemony?
In its efforts to make the Chinese currency yuan, or reminbi, more international and to break the US dollar’s global dominance, China has launched its own petro currency: Petro-yuan. With a step that is likely to upend, and reshape, the global oil market, the Shanghai International Energy Exchange launched the first crude futures contracts priced in Chinese reminbi, or yuan, in March. China is the world’s biggest importer of oil with purchases of around nine million barrels a day and if it actually switches to yuan for oil payments, the implications on global oil trade could be huge. It will not only give a boost to President Xi Jinping’s aim to make China a formidable power at the global level, but will also be a perpetual threat to the hegemony of the American dollar, especially because Beijing is willing to grant privileges to the countries which will switch to settlements in the Chinese currency.
On March 26, China kicked off its first-ever yuan-denominated oil futures on the Shanghai International Energy Exchange. Beijing’s launch of yuan-denominated oil futures may facilitate the internationalization of the Chinese currency and deal a heavy blow to the longstanding dominance of the US petrodollar. Currently, the US dollar is used as the contract currency in the global hydrocarbon trading system, as well as for other commodities. This is what largely provides the dollar with its status of the world’s leading reserve currency. However, the yuan is seeking to dislodge the American petrodollar from one of the fastest growing oil markets in the world.
Since the 1970s, the oil trade has almost entirely been conducted in US dollars, even when buyers and producers are not American. For instance, China is the world’s biggest crude consumer and buys most of its oil from Russia. But, most settlements between the two countries are still in US dollars. The launch of the petro-yuan now allows Moscow and Beijing to use national currencies instead. This means that settlements for Russian oil deliveries to China, which have reached 60 million tonnes per year, can be done without using the dollar.
The ramifications of the dollar-denominated oil trade are immense: because oil is priced in dollars, there is huge demand for the greenback, lending the US economic and strategic power.
For China, there are a lot of upsides to this gambit. An oil futures market based in yuan will stimulate demand for the Chinese currency, which China believes will lend it a strategic clout. That money is also more likely to be recycled back into the Chinese economy. The US has been able to run huge budget deficits, borrowing money at extremely low rates because of the demand for its currency. Petrodollars continuously flow back into the US economy, creating investment and economic growth that might not otherwise occur. The dollar has also long been one of the premier safe havens for investors around the world.
China hopes to replicate this dynamic. And as the largest oil importer in the world, there is a great deal of logic in having oil contracts trade in yuan.
But it won’t be easy to unseat the greenback. There are certain obstacles to convincing large oil-producers and consumers for using the yuan and investing in the Shanghai benchmark. Without some major countries participating, like, say, Saudi Arabia or Russia, it will be difficult to create a market that is deep and liquid enough to make a difference.
Some market analysts have expressed doubts over the success of the petro-yuan, citing Beijing’s yearning for total control over trading as one of the key reasons for a potential bust. However, China’s yuan-backed oil futures managed to make a strong debut with overnight trade volumes initially outstripping transactions of internationally recognized benchmark Brent. Some 62,500 contracts reportedly changed hands during the first session, as domestic and international oil investors joined the trading.
The impressive start gives deeper cause for optimism about the newcomer.
Impact on global politics
As the prospect of petro-yuan becomes a reality, China will, in effect, be making a claim to global oil reserves. That would definitely be against American interests as the “black gold” has been practically backing the US dollar as well as humungous US debt. Globally, if you needed oil, you definitely needed to have dollar reserves. These dollar reserves could never be materialised unless goods and services made it to American economy or in some cases through expats sending foreign exchange to their home nations. Most global dollar reserves depend on export from dollar-starved nations to American consumers. These reserves would always land back in American economy through the banking system. Again, the same dollar would have to be competed for globally by offering goods and services to American consumer as the world is in perpetual need of oil for most of its energy needs. It means that all the economies have to be constantly running for dollar while the US could print at ease in the name of national and foreign debt.
China sits in a comfortable position as it owns almost 1,200 billion dollars of American debt. It, therefore, does not have to fret about launching the petro-yuan, as, at-least in its initial stages, practically the petro-yuan will itself be backed by the American debt owned by China. On the other hand, Russia has been ever more willing to back the idea of global trade independent of the dollar. Also, the initiative of BRICS alliance already targeted the dollar-heavy world of trade and economics. While Russia and China have stepped up their alliance to a level where the Russian ruble is an acceptable tender at many places in China, many other countries sitting on oil reserves are naturally averse to petro-dollar. Among these nations Iran and Venezuela are those who have to constantly battle sanctions hurled at them from the cross-Atlantic “moral” police. These sanctions limit the trade potential of these oil-rich nations. As a result, these countries face constant currency depreciation while an America whose extravagance far exceeds its inland oil output and depends on global oil reserves for its huge debt has got its currency-power dictating sanctions on these countries. Both Iran and Venezuela could have a great economic outlook had it not been for the petro-dollar and the power of hindering other nations’ claim to their own resources it has bestowed upon the US. While Iran and Venezuela don’t enjoy the independence to live within their own “means”, America reserves the right to live beyond its while putting the burden of its lavish spending on global economy courtesy petro-dollar.
Therefore, Iran and Venezuela shall be happy participants in petro-yuan’s success and shall also have an opportunity to avoid the oppressive sanctions they are subjected to banning on them their own natural wealth. Would this practically mean putting a stop to American economic tyranny? Has the petro-dollar been potentially checkmated? We are far from that yet. If the dragon is “sanctioned” from the tool that has propped up its belly, at the expense of others’ appetite, it may leash out brute force against the competition. Since petro-dollar is not a moral tool in global economic competition, we don’t expect it to be defended and protected in a moral way. To delay or halt its economic death, America has every reason to trigger a war in Syria, for example, whose oil industry was well penetrated by Russia before American backed militants stepped in to essentially protect the American lust for oil. This western agenda has been pushed so explicitly that while Bashar-al-Assad had to face the European Union import ban on oil and petroleum products in September 2011, in April 2013 the same European Union would decide that member states could support the Syrian opposition by buying oil from militant-controlled areas; Hence, the birth of petro-terrorists to protect the petro-dollar. If that is the depth of immorality that Europe and America can go to protect their oppressive economic hold on the world it would take more than petro-yuan to thwart their malicious agenda. When it comes to the “black gold”, western bloc will be ready to engage any power by attacking its global interests be it through a false flag operation through ISIS and a “reaction” thereafter, or by pushing North Korea or Syria against the wall.
Is it a deathblow to Petrodollar?
Does the launch of the petro-yuan represent the ultimate deathblow to the petrodollar – and the birth of a completely new set of rules? Not so fast. That may take years, and depends on many variables, the most important of which will be China’s capacity to bend, tweak and ultimately rule the global oil market.
As the yuan progressively reaches full consolidation in trade settlement, the petro-yuan threat to the US dollar, inscribed in a complex, long-term process, will disseminate the Holy Grail: crude oil futures contracts priced in yuan fully convertible into gold.
That means China’s vast array of trade partners will be able to convert yuan into gold without having to keep funds in Chinese assets or turn them into US dollars. Exporters facing the wrath of Washington, such as Russia, Iran or Venezuela, may then avoid US sanctions by trading oil in yuan convertible to gold. Iran and Venezuela, for instance, would have no problems redirecting tankers to China in order to sell directly in the Chinese market – if that’s what it takes.
Will this new system change the way oil is traded globally?
Probably not in the short term. Traders can’t move yuan freely in and out of the Shanghai commodity exchanges yet. That said, it’s unclear how much of a roadblock this is given that INE will be based in the Shanghai FTZ.
Also, even with exchange convertibility, international investors and resource-trading companies need to build up enough confidence in the INE as a trading hub. That requires time and, crucially, the tried, tested, and extensive data infrastructure to support the market, which China doesn’t have right now. That said, in the longer term, we believe that yuan oil trading will shift the structure of the global oil market, provided two things happen.
Firstly, China will have to remove, or substantially reduce, capital controls for yuan-priced oil trading to take off and allow global commodity trading houses access to the INE. We think this is already in process, although happening gradually, based on recent policies to make the RMB more market-determined and ease rules on foreign banks’ yuan businesses.
China’s other landmark changes, like giving institutional investors direct access to the Chinese bond market, expanding access via the Bond Connect programme in 2017, and launching the Shanghai and Shenzhen Stock Connect links with Hong Kong, show the government is intent on the necessary reforms to open the economy to international investors.
Secondly, China’s oil trading partners, like Saudi Arabia, Russia and Iran, will have to agree to accept yuan for their oil exports to China. This is also taking shape because Russia already accepts it for oil exports, as does Iran, and we expect Saudi Arabia to soon begin invoicing China in yuan.