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Petro-yuan challenges the petro-dollar

Petro-yuan challenges the petro-dollar
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Image: Yuan and Dollar – courtesy Russia Today

By Charles F Moreira, Editor

China has been trading oil in yuan with Russia and Iran since before 2013, whilst in September 2017, Venezuela’s President Nicholas Maduro announced that his country had already priced its oil in yuan to free itself from its reliance on the US dollar and to overcome the sanctions imposed on his country by US President Donald Trump.

“If Russia, Iran, Angola, Sudan, and Venezuela all convert just their oil sales to China into the Chinese Yuan the world will see over 5 million barrels per day traded not in US dollars but in Chinese Yuan”, wrote Dan Collins in The China Money Report of 15 April 2013. “Good night Petro Dollar…Hello Petro Yuan.”

Meanwhile, speculation has been rife over the impact upon the dominance of the US-dollar for payment in international oil trade, in the years before and shortly after China launched trading in its yuan-backed crude oil contract on the Shanghai International Energy Exchange on 26th March 2018, six years after its original planned launch date.

Speculation also continues as to the impact China’s move will have upon current global crude oil benchmarks, include the Intercontinental Exchange’s Brent crude oil contract and the New York Mercantile Exchange’s West Texas Intermediate.

The Shanghai International Energy Exchange is a 5 billion yuan (US$790 million) subsidiary of the Shanghai Futures Exchange and the contract is based upon medium-density crude.

According to the South China Morning Post, trading of the new oil futures contracts for September settlement started on the Shanghai International Energy Exchange at 440.20 yuan (US$69.70) per barrel and some 18,540 lots are said to have been sold and purchased so far.

On the day of the launch, Russia Today reported soaring global oil prices, with Brent Crude at US$71 a barrel for the first time since 2015 and West Texas Intermediate (WTI) at its highest level in three years at US$66.55 per barrel.

A time or writing, Brent had pulled back to US$69.53 per barrel on 28 March 2018 and WTI had pulled back to US$64.38 per barrel, according to the Oil-Price.net portal.

It also will be good news for Malaysia if these oil price prices rises sustain at these levels or rise even higher, since the strength of the ringgit versus the U.S. dollar fairly closely tracks the price of Brent crude. According to the XE.com currency site, the ringgit closed at just under RM3.87 to the US dollar on 29 March 2018.

The ringgit has been gradually strengthening from its low of RM4.49 to the US dollar on 4 January 2017 (following the “Trump effect” which drove the US dollar up the day after his election), whilst prices of Brent Crude have been gradually rising from a low of under US$40 per barrel in late 2015.

An ‘historic’ move

According to Russia Today, experts regard China’s yuan-dominated contracts (dubbed the “petro-yuan”) as historic, since for the first time foreign investors can access a Chinese commodity market, ending years of setbacks and delays since China’s first attempts at listing the securities in 1993.

At the same time, this launch of the petro-yuan is regarded as a blow to the US dollar as the primary settlement currency for oil futures contracts, as it had been weakening in recent months, and on the day of the launch, the US dollar dropped to a 16-month low against the Japanese yen, though it held steady against a basket of six major currencies.

A credible game changer?

With China now being the world’s largest oil importer, the contracts may not only help to win some control over pricing from the major international benchmarks, but also promote the use of Chinese currency in global trade.

Meanwhile, Ann Lee, Adjunct Professor of Economics and Finance at New York University and author of the book ‘What the US Can Learn From China’, told Russia Today that the US dollar will get weaker, as soon as other nations have a real credible alternative to it.

“It is more of a game changer for the US. As soon as other nations have a real credible alternative to the US dollar, they can dump dollars and switch to the yuan which can spark a dollar crisis. If that happens, not only will there be inflation from the tariffs, but also from the flood of dollars,” said Lee.

Also, whilst financial guru Peter Schiff (who accurately predicted the 2008 recession) firmly believes that the consequence of the Federal Reserve manipulating the economy will be the crash of the dollar – “They actually made the bubbles bigger than the ones that popped. So now, the dollar’s collapse is going to be that much bigger, because it’s now a bigger bubble with more air to come out of it. And I think they have no more tricks up their sleeves. When this happens – it’s over”, Mac Slavo, writing in SHFTplan.com of 26 March 2018, believes that the petro-yuan could also play a role in the dollar’s collapse.

Or for practical reasons?

However, according to the South China Morning Post of 15 February 2018, Huang Lei, an independent commodity futures analyst, believes that the role of the yuan-denominated contract has been overstated over the past years and that it is far from becoming a regional benchmark.

According to Lei, with imported crude oil accounting for over two-thirds of China’s total oil consumption, China lacked bargaining power over oil and had to pay higher prices for it when crude prices were high.

Until now, crude oil sold in Asia was mainly priced against the Dubai, Oman and dated Brent benchmarks or Oman crude futures on the Dubai Mercantile Exchange, so by creating her own oil futures market, China hopes to have some bargaining power over crude oil prices as she becomes increasingly reliant on oil imports, and this move by China provides her with an alternative to the above exchanges.

At the same time, it also provide alternatives for crude oil buyers and sellers in other countries as well and is also expected to promote the use of China’s yuan in global trade.

Enthusiastic foreign participation

According to Reuters on the day of the launch, close to 15.4 million barrels of Shanghai’s most-active September contract changed hands in the two and a half hour morning session to 03.30 UTC (11.30am Malaysian time), initially exceeding volumes traded in the Brent May contract, before that benchmark opened around 05.00 UTC.

Glencore plc, an Anglo–Swiss multinational commodity trading and mining company was first to trade a deal on the Shanghai’s new market, whilst Swiss-based commodity trader Trafigura, US-based Freepoint and independent refiner Shandong Wonfull were other early participants.

Whilst the early involvement of big international players was a morale booster for the new market, however China’s state-owned oil giants like PetroChina and Sinopec are expected to provide a significant amount of liquidity in the long term.

Speculative retail and institutional investors drove much of the launch-day’s liquidity, according to Chen Tong, a Shanghai-based senior crude analyst at First Futures.

“In the short-term, we believe price fluctuations will reflect domestic crude oil supply and demand. In the long run, yuan crude price will mirror the moves of Brent,” he said.

The most-active September contract opened at 440.4 yuan (US$70.03) per barrel versus a reference point of 416 yuan, jumping as high as 447.1 yuan in the first few minutes.

The jump came after Brent futures for May delivery opened above US$70 per barrel for the first time since January on expectations that leading OPEC member Saudi Arabia may extend supply cuts into 2019 and also over concerns that the United States may re-introduce sanctions against Iran.

At the end of the morning session, Shanghai prices were up 3.92% at 432.4 yuan, with 30,742 lots traded.

China’s exchanges count each side of a trade — the buy and the sell — as two lots, meaning the total oil changing hands was 15,371 lots, equal to 15.37 million barrels.

Brent and WTI, in contrast, were down by that time, weighed down by concerns over a looming US trade dispute with China.

 

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