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Friday 23 February 2018

Petrodollar to Petroyuan?-IDSA-DR SR DADWAL

February 22, 2018
In a move that could cause a major shift in global energy markets and also allow it to play a bigger role in the global economy, China is planning the launch of a yuan-denominated oil futures exchange. After several postponements, Beijing is finalising plans to launch its oil futures contract on the Shanghai International Energy Exchange, or what is referred by its acronym, INE, on March 26, 2018. The exchange plans to handle seven kinds of crude, particularly from the Middle East, including Iraq’s Basra Light, Dubai and Oman crude. Chinese oil companies like Sinopec and the small, independent refineries which are referred to as “teapots” that import large consignments from the region, are expected to use the INE.
If all goes according to plan, the launch will provide China with the opportunity to create an Asian crude oil benchmark that would better reflect pricing for the oil imported and consumed in Asia, the world’s top importing region. The move is designed to give China more clout in crude pricing as well as promote its currency as a truly global one.

Petrodollar to Petroyuan?

The critical role of finding an alternate currency to the US dollar (USD) to trade in oil holds the key to currency domination. Most of the oil, with a few exceptions now coming to the fore, is sold and bought in USD, which means all oil consumers have to purchase dollars to buy oil. While the Bretton Woods system allowed the USD to be designated as the international reserve currency, it was the 1974 US-Saudi deal that established and ensured the dollar’s position.
For years now, China has been trying to translate its growing economic strength into global influence, and international acceptance and use of its currency, as in the case of the dollar, would go a long way in allowing it the leverage it seeks. At present, the US dollar retains top position. According to recent International Monetary Fund (IMF) data, the USD accounted for 63.5 per cent of all reserves, followed by the Euro at 20 per cent, while the yuan’s share in the world’s forex reserves is a paltry 1.12 per cent in Q3 2017.1 But China wants the yuan to play an increasingly important role in global trade, and where better than to start with the oil trade.
The Chinese currency did receive a boost, albeit symbolic, in 2016, when the IMF included the yuan in its basket of global currencies that determine the value of its international reserve asset, the Special Drawing Right (SDR). However, thereafter, the yuan depreciated, and Beijing’s efforts to prop up the currency, including by the imposition of curbs on capital outflows, dampened its international appeal. But recently, the Chinese government has been showing signs of relaxing the micro-management of the exchange rate, which resulted in the yuan climbing against the dollar.2

Will the Chinese gambit succeed?

There are some takers for the yuan. Russia and Iran have been using the yuan to settle some oil transactions since 2015. Both countries have been slapped with US sanctions, including banking restrictions, and both export large volumes of crude to China. Venezuela too has shown some interest in trading in yuan, and Angola and Nigeria are also selling some oil and gas in the Chinese currency. And as recently as January 2018, Pakistan’s central bank said it has officially adopted the yuan as a currency for trade with China.3 Several banks, including HSBC and Deutsche Bank, are also picking up the yuan for their currency reserves, which is indicative of the growing acceptance of the yuan as an international currency, although it remains far behind the dollar.4
The real test of the yuan’s international acceptability, however, will be Saudi Arabia. If the Kingdom, which was largely responsible for instituting the USD as the global currency, accepts the yuan, even partly, for its exports to China, that will go a long way in making the Chinese currency more acceptable internationally.
Nevertheless, the success of the yuan oil futures contract will depend largely on market regulation (and room for intervention) on the market, which could deter international investors from bringing huge volumes into the contract. Some analysts believe that while it makes sense for the world’s key oil import market to launch yuan oil futures, it would take years for the yuan to really threaten the supremacy of the “entrenched” petrodollar.
China has long wanted to host a global benchmark. As the world’s top energy importer, it wants more clout in a market worth trillions of dollars. It also wants more international trade overall to be done in renminbi (the yuan’s official name). Hence, pricing oil in yuan would advance both goals.

Conclusion

The setting up of an Asian oil benchmark will reflect the reality of the current oil pricing mechanism, which is dominated by Asia, as against the traditional one that was designed for a time when Asian countries were not major energy consumers. It is therefore understandable that an alternate currency should be instated. But if the yuan has to be accepted as the alternative to the USD and become a safe haven in times of crises, rather than an instrument for trade and portfolio diversification only, China will have to pursue and sustain the reforms it has introduced. Further, global investors continue to buy US treasury bills and bonds whenever they seek a safe haven to park their money. It merits recalling that the US dollar superseded the British pound sterling only after World War II, although the American economy had overtaken Britain’s in the late 1800s.

Therefore, while the US dollar’s continued dominance is neither inevitable nor necessarily desirable, it does not mean that the renminbi/yuan will replace it. Undoubtedly, its use in trade, bond issues and sovereign reserves has grown, that too in a relatively short time. But China’s unreliable or illiquid financial markets remain a major impediment. China will have to pursue reforms to strengthen domestic debt markets, improve corporate governance and bring in more regulatory transparency and enforce the rule of law in order to attract and absorb huge global financial flows.5 There is also the danger that a considerable fall in the US dollar’s value will undoubtedly have ripples in global financial markets, which will affect many of China’s leading trade partners. Therefore, while no one expects the dollar to abdicate its reign just yet, the Shanghai exchange may mark the first sign of cracks forming in the US dollar’s edifice

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