Petro-Yuan Looms – How China Will Shake Up The Oil Futures Market

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Originally appeared at Zero Hedge

The “huge story”, as Graticule’s Adam Levinson called it, will, it appears, be a “wake up call” for the West that seems to happily be ignoring this potential bombshell that is China’s looming launch of domestic oil futures trading.

Additionally, Levison warns Washington that besides serving as a hedging tool for Chinese companies, the contract will aid a broader Chinese government agenda of increasing the use of the yuan in trade settlement… and thus the acceleration of de-dollarization and the rise of the Petro-Yuan.

“I don’t think there’s any doubt we’re going to see use of the renminbi in reserves go up substantially”

China has been planning this for a number of years and given rising tensions, now seems like a good time for China to flex a little.

The Shanghai International Energy Exchange, a unit of Shanghai Futures Exchange, will be known by the acronym INE and will allow Chinese buyers to lock in oil prices and pay in local currency. Also, foreign traders will be allowed to invest — a first for China’s commodities markets — because the exchange is registered in Shanghai’s free trade zone. Even  Bloomberg admits there are implications for the U.S. dollar’s well-established role as the global currency of the oil market, as Sungwoo Park sums up some of the key questions

1. When will trading begin?

According to the Shanghai-based news portal Jiemian, which cited an unidentified person from a futures company, trading is expected to start Jan. 18. Multiple rounds of testing have been carried out and all listing requirements met. The State Council, China’s cabinet, was said to have given its approval in December, one of the final regulatory hurdles. The push for oil futures gained impetus in 2017 when China surpassed the U.S. as the world’s biggest crude importer.

 

Petro-Yuan Looms - How China Will Shake Up The Oil Futures Market

2. Why is this important for China?

Futures trading would wrest some control over pricing from the main international benchmarks, which are based on dollars. Denominating oil contracts in yuan would promote the use of China’s currency in global trade, one of the country’s key long-term goals. And China would benefit from having a benchmark that reflects the grades of oil that are mostly consumed by local refineries and differ from those underpinning Western contracts.

3. How do oil futures work?

Futures contracts fix prices today for delivery at a later date. Consumers use them to protect against higher prices down the line; speculators use them to bet on where prices are headed. In 2017, oil futures contracts in New York and London outstripped physical trading by a factor of 23. Crude oil is among the most actively traded commodities, with two key benchmarks: West Texas Intermediate, or WTI, which trades on the New York Mercantile Exchange, and Brent crude, which trades on ICE Futures Europe in London.

4. Why didn’t China begin trading futures until now?

Lower crude prices have played a part. Chinese oil futures were proposed in 2012 following spikes above $100 a barrel, but prices in 2017 have averaged little more than $50. There’s also concern over volatility. China introduced domestic crude futures in 1993, only to stop a year later because of volatility. In recent years, it repeatedly delayed its new contract amid turmoil in equities and financial markets. Such destabilizing moves have often prompted China’ government to intervene in markets in one way or another.

5. What’s China’s track record in commodities?

Nickel was the last major commodity to be listed there in 2015; within six weeks, trading in Shanghai surpassed benchmark futures on the London Metal Exchange, or LME. In China, speculators play a far greater role, boosting trading volumes but making markets susceptible to volatility. In early 2016, the then-head of the LME said it was possible some Chinese traders did not even know what they were trading as investors piled into everything from steel reinforcement bars to iron ore. Steep price rises relented when China intervened with tighter trading rules, higher fees and shorter trading hours.

6. Will foreigners buy Chinese oil futures?

That remains to be seen. Overseas oil producers and traders would need to swallow not just China’s penchant for occasional market interventions but also its capital controls. Restrictions on moving money in and out of the country have been tightened in the past two years after a shock devaluation of the yuan in 2015 prompted a surge in money leaving the mainland. Similar hurdles have kept foreign investors as bit players in China’s giant stock and bond markets.

7. Could the yuan challenge the dollar’s dominance in oil?

Not any time soon, since paying for oil in dollars is an entrenched practice, according to some analysts. Shady Shaher, head of macro strategy at Dubai-based lender Emirates NBD PJSC, says it makes sense in the long run to look at transactions in yuan because China is a key market, but it will take years. Bloomberg Gadfly columnist David Fickling argues that China doesn’t have “nearly the influence in the oil market needed to carry out such a coup.” On the other hand, paying in yuan for oil could become part of President Xi Jinping’s “One Belt, One Road” initiative to develop ties across Eurasia, including the Middle East. Chinese participation in Saudi Aramco’s planned initial public offering could help sway Saudi opinion toward accepting yuan, which is used in only about 2 percent of global payments.

With regards that final point from Bloomberg, Pepe Escobar disagrees, recently concluding, the era of the petro-yuan is at hand

Intractable questions referring to the US dollar as top reserve currency have been discussed at the highest levels of JP Morgan for at least five years now. There cannot be a more politically charged dossier. The NSS duly sidestepped it.

The current state of play is still all about the petrodollar system; since last year what used to be a key, “secret” informal deal between the US and the House of Saud is firmly in the public domain.

Even warriors in the Hindu Kush may now be aware of how oil and virtually all commodities must be traded in US dollars, and how these petrodollars are recycled into US Treasuries. Through this mechanism Washington has accumulated an astonishing $20 trillion in debt – and counting.

Vast populations all across MENA (Middle East-Northern Africa) also learned what happened when Iraq’s Saddam Hussein decided to sell oil in euros, or when Muammar Gaddafi planned to issue a pan-African gold dinar.

But now it’s China who’s entering the fray, following on plans set up way back in 2012. And the name of the game is oil-futures trading priced in yuan, with the yuan fully convertible into gold on the Shanghai and Hong Kong foreign exchange markets.

The Shanghai Futures Exchange and its subsidiary, the Shanghai International Energy Exchange (INE) have already run four production environment tests for crude oil futures. Operations were supposed to start at the end of 2017; but even if they start sometime in early 2018 the fundamentals are clear; this triple win (oil/yuan/gold) completely bypasses the US dollar.

The era of the petro-yuan is at hand.

Of course there are questions on how Beijing will technically manage to set up a rival mark to Brent and WTI, or whether China’s capital controls will influence it. Beijing has been quite discreet on the triple win; the petro-yuan was not even mentioned in National Development and Reform Commission documents following the 19th CCP Congress last October.

What’s certain is that the BRICS supported the petro-yuan move at their summit in Xiamen, as diplomats confirmed to Asia Times. Venezuela is also on board. It’s crucial to remember that Russia is number two and Venezuela is number seven among the world’s Top Ten oil producers. Considering the pull of China’s economy, they may soon be joined by other producers.

Yao Wei, chief China economist at Societe Generale in Paris, goes straight to the point, remarking how “this contract has the potential to greatly help China’s push for yuan internationalization.”

It ain’t over till the fat (golden) lady sings. When the beginning of the end of the petrodollar system – established by Kissinger in tandem with the House of Saud way back in 1974 – becomes a fact on the ground, all eyes will be focused on the NSS counterpunch.

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  • Rodger

    New solar is now cheaper than new coal in Australia. Renewables will end the oil age in 20 years anyway. China has vast high altitude deserts ideal for solar farms, green houses and heavy industry.

    • Weldon Cheek

      That sounds like sense,the Chinese are probably just upsetting the apple cart with this move,there is no future that sees carbon fuels use as it has been,technology is the way forward.

  • TiredOfBsToo

    The best thing about the Petro-Yuan, I believe, is that it will force the US to concentrate on it’s own land mass rather than everyone else’s.

    • Harry Smith

      If you are USA citizen, then it’s a very sad news for you. USA govt can grow the debt without any limit until US dollar is main world reserve currency. Literally, while everyone in the world needs dollars they can print it as much as they want. If the demand of the dollars falls then billions of “useless” papers have to return to the “motherland”. Besides of the inflation it will down the price for the govt treasures. And now, just calculate how much it will be for a 1% rate increase in case of the 20 trillions debt. And if you think that Trump or Hillary will concentrate on domestic issues rather than flew away to, let’s say, Israel – you’re an extra optimistic or extra infantile man.

      • TiredOfBsToo

        Trump & Clinton are just representatives of the parasites that infest the government of the US. I’ve no doubt that America will have to undergo the transition that Russia had to at the end of the 90’s, but I look forward to not having bases in all parts of the world and the US government working for the people of the US rather than the parasites that infest it currently. As an added bonus, the rest of the world will be left alone to manage their own affairs without the fear of being bombed or enslaved by the parasites with the unlimited printing press.

        • LR captain

          those base are going to be ground zero for many conflicts as the US orders it troops to damage enough public infrastructure as it can. before withdrawing to the coasts were to the US navy will take them back to the homeland.

          the plan was to hit as much infrastructure it can before grinding down any forces sent at the main land. Thus the US would be put back in a post WW2 situation were they were only ones who did not have damaged Infrastructure. How ever the neocons greed and lack of force sight screwed themselves over.

        • Harry Smith

          The real rulers of the USA are at the Wall st. They got the absolute power in the times of Ronald Regan presidency. All the USA ruling elites are nothing but their puppets. As for your expectation of transition like in Russia, well, USA has a very huge differences. First of all, you have 2nd amendment and a lot of guns and ammo, while in the USSR guns were restricted. Second, you have millions of citizens who gets food stamps and welfare, and they have guns too! Third, when the USSR collapsed the population was in relatively equal wealth condition. And if you make an equation with these 3 variables and put 2 conditions: the govt stops pay welfare and inflation is big enough – the result is nationwide massacre.
          Anyway: it is the pessimistic scenario, but there is a saying: pessimist is just a good informed optimist.

          • TiredOfBsToo

            “They got the absolute power..”

            I would disagree with that statement. The Bankers began their rise in 1863 with the National Banking Act and strengthened their position with the creation of the Federal Reserve in 1913. With the end of Franklin Roosevelt’s Presidency, the country took a dramatic turn for the worst. The bankers solidified their positions with the founding of the CIA after WW2 and the appointment of the chief psychopath, Allen Dulles, as it’s head. Assassinations, regime change, destruction of countries for profit are all attributable to the insatiable greed of Wall Street and it’s enforcement arm, the CIA. President JFK sought to change things which is why the CIA assassinated him. Since then, no one has held the reigns of power to threaten the status quo. Reagan was just another link in the long chain of Wall Street criminality.

            I do agree that deep trouble lies ahead, just how that will unfold is hard to say, but I expect it to be everyone for themselves unless someone with intelligence assumes the reigns of power.

          • Harry Smith

            There is another variable in the equation: nuclear weapons. Do not think “everyone for themselves” has a high probability, at least for the whole territory. Russia or China or even EU must try to secure USA nuclear arsenal in case of the chaos inside of USA.

          • Bolter10

            Nuclear weapons cannot be used without codes. The days are gone when a aircraft, millisle base or sub commander could launch weapos on his own.

          • Harry Smith

            Any code for bombs? Any guarantee that a patriotic nut would be able to get these codes in the middle of the chaos?

          • Bolter10

            Look at K-129. This system needs not only three keys from local commanders but also a code from HQ. It self destructed depsite an unauthorised launch. After the 60’s when nuke bombers and subs actually could launch an attack, both the Russians and US realized it was not a good idea, especailly after it was learned the Cuban army had control over a tactical nuke (fired from a howitzer), that they wanted to use and Kruschov didn’t know, nor did he know about the Russian sub that met the US blockade and was depth charged by the US Navy. Trouble was the sub commanders had orders to reply with nuke torpedos if they felt threatened and they had no contact with base for weeks. Luckily one of the three commanders decided not to give his key to fire the torpedo. Then again maybe you don’t need a nuke. Israel has already stopped three pilots from doing a kamikaize into the temple in Jerusalem which according to belief of many is the begining of the ‘end of time.’

          • Harry Smith

            Maybe you are right about codes. But I still believe that in case of the chaos inside of USA major forces will take any chances to gain control over the US nuclear arsenal.

          • Bolter10

            ? what do you mean, please explain.

          • Harry Smith

            Lets imagine USA falls in “without-rule-of-law” situation. Federals can’t control the states and states govts are not functioning because of lack of money and power. Multiple riots, hordes of looters and etc. If I were the one who takes decision in the govt of Russia, China or EU, I would use this situation as reason to invade and take controls over the nuclear arsenal. Just only for that and not for stay any longer on the US land. And if I were extremely rationale, I would open, before withdrawing the troops, conventional arsenals for black and latino gangs to bring more chaos inside the USA.

          • Bolter10

            Hhhmm, every nuke armed nation has safeguards and they wouldn’t hand them over to a foreign country. If one was to invade to secure nukes it would unite a country against the invader and perhaps give a pretext to use them. It’s a bit like worrying if your seatbelt will work in a crash. Anyway does any country want to invade US with 2-3 guns per family? More likely than nuke war, will come internal collapse, riots etc and the last thing on any ones minds will be nukes cuz you can’t use them unless you want a death sentance and possible armageddon in climate change and defnetly no food left to fight over, never mind wondering gold replace barter for basic neesd.

          • Harry Smith

            You got it right. I’m talking about WROL situation. When USSR collapsed many USA “advisers” started monitoring mission over the USSR nuclear arsenal and build in Russia some plants to destroy it. All the USSR republics except Russia destroyed or transported to the Russia it’s nukes. But because USA elites thought Russia will never reborn they did not assured the total nukes disassemble before Putin came to the power. So, please, explain me why you think that in case with the USA will be different? And what makes you to think that other countries will make the same mistake USA made with Russian nuclear weapons?

          • Bolter10

            Well said!

      • LR captain

        they will just start a war.

        • Harry Smith

          They are trying their best! :)