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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.

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