UBS: "The Petroyuan Will Undermine America's Dominant Role And Create A Sea Change In Global Markets"

From Hayden Briscoe, head of Fixed Income, Asia Pacific at UBS

RMB-denominated oil contracts began trading for the first time in Shanghai on March 26. We believe that in the long term this will ultimately change how oil is traded globally, create a Petroyuan currency flow, increase the role of the RMB as a global trading currency, and compel investors to up their allocations to Chinese financial assets.

Why now?

From March 26, seven oil grades will be tradeable on the Shanghai International Energy Exchange (INE), allowing Chinese buyers to buy forward in RMB. Since INE is based in Shanghai's Free Trade Zone (FTZ), foreign traders will be allowed to trade in the market.

China passed the US as the world's largest oil consumer in 2016. Accordingly, China wants to pay for its huge import bill in its own currency (RMB) rather than USD.

More importantly, however, China wants the new oil trading plan to promote RMB internationalization, i.e. forcing wider adoption of the RMB as a global trading currency, and switching to RMB payments for major imports is part of this process.

The emergence of Petroyuan - RMB-denominated revenues collected by the world's largest oil producers - is a natural development from this process

Will this new system change the way oil is traded globally?

Probably not in the short term. Traders can't move RMB 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 RMB 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 RMB-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' RMB businesses.

China's other landmark changes, like giving institutional investors direct access to the Chinese bond market, expanding access via the Bond Connect program 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 RMB for their oil exports to China. This is also taking shape because Russia already accepts RMB for oil exports, as does Iran, and we expect Saudi Arabia to soon begin invoicing China in RMB.


The Petroyuan – why it really matters

Oil trading in RMB is as much about politics as practicality.

The 2008 Global Financial Crisis (GFC) taught the world and China that an over-reliance on key commodities priced in USD can be risky. When USD prices of key commodities rose following the GFC, higher food and energy import bills risked supply security, something a country like China can't afford.

As well as protecting food and energy security, China wants a more active role in global politics and the global economy. As the world's second largest economy, it wants global systems, like oil trading, to reflect China's status.

Historically the US has been the dominant oil consumer, and oil trading reflects this because it is priced in USD. In the 1970s, Saudi Arabia and the US bilaterally negotiated oil trade settlement in USD and this gave birth to the Petrodollar world we still live in today.

This way of trading has given the US what's been described as an 'exorbitant privilege' – where oil exporters recycle their dollar receipts back into US financial markets, keeping US interest rates low and supporting persistent current account deficits.

But that's about to change – especially now that China has become the largest global oil consumer. China's role is only expected to increase, since BP forecasts annual demand will grow 30.6% to 753 million tons per year in 2040, while the US will likely reduce their reliance on oil imports by developing domestic shale oil capacity.

As the dominant customer, particularly for major oil exporters like Russia, Venezuela, Iraq, Iran, and Saudi Arabia, China's market means leverage, and many of these suppliers have either already agreed to price their sales to China in RMB, or are actively considering it.

If, or rather when, China's total oil import bill gets priced in RMB, that's going to create large piles of RMB reserves in oil exporting countries that will either be spent on Chinese exports, or recycled into China's financial markets, giving China much more heft in the global economy.

This will have two principal effects: increased demand for RMB assets and a switch out of the USD for trading purposes, which will likely undermine the United States' dominant role in the global economy and create a sea change in global asset allocation to China's financial markets.

And that's why the launch of oil trading contracts in RMB really matters.

Comments

petroglyph Sun, 04/29/2018 - 21:34 Permalink

 This explains the bombing in Syria today. With Iran trading for oil in Yuan or Euro's, the petrodollar is gasping for air. The west has to stop Iran, like it did Iraq and Libya, or it is doomed.

Harry Lightning RozKo Sun, 04/29/2018 - 21:41 Permalink

The US would be the beneficiary of a world that drops the dollar as a reserve currency. Because if that occurred the US would be forced to employ fiscal discipline in its budgeting. Failure to become fiscally responsible is the greatest threat to the US economic health looking forward, so the sooner they are forced to stop their profligate spending and balance their annual budgets, the sooner they will be on the path back to economic well-being.

In reply to by RozKo

silverer Harry Lightning Mon, 04/30/2018 - 08:33 Permalink

Well Harry, you've forgotten something. Before things get better, the population has to make it through the gauntlet of rotating knives that have been build for the middle class over the last 40 years or so. Eventually it will improve, but not before 10 years of misery. And even then, count on the seasoned criminals running the country to continue to take their "cut" anytime they get an opportunity. The only way for the population to win is to force the governments in every state to establish public banks, like the one they have in North Dakota. Anything short of that is a recipe for a repeat.

In reply to by Harry Lightning

Harry Lightning Sun, 04/29/2018 - 21:39 Permalink

The reason why the prediction in this article never will come ot pass is that for it to happen, the Chinese government would have to print so much money to satisfy the oil trade that inflation in China would skyrocket. As the Chinese has a huge amount of national debt outstanding, the rise in Chinese inflation would collapse the secondary markets for their debt securities, virtually eliminating their ability to borrow in international financial markets.

Locked out of international markets for debt issuance and experiencing a hyper-inflation that would prevent them from monetizing their own new debt, China's economy would become starved quite rapidly, and they would not be able to sustain the infrastructure necessary to maintain their export economy. 

Somewhere along the way if it has not happened already, the Chinese will realize that they cannot afford to have the petroyuan become so large a medium of commerce that it destroys their economy. Which means that while oil will trade in yuan, it will be limited in scope and have little effect on the preference the oil market will continue to have for dollar-based transactions. 

 

OverTheHedge ProstoDoZiemi Mon, 04/30/2018 - 05:51 Permalink

That is the whole point of having the reserve currency - you MUST print like a frenzied counterfeiter because everyone and his dog will NEED your currency to buy oil. Therefore no issues with inflation, until you lose the reserve status, whereupon all those units of currency that used to swill around the world buying and selling oil, will have no use, and will be swapped for the new reserve currency. That is the point at which inflation will raise its head.

In reply to by ProstoDoZiemi

East Indian Sun, 04/29/2018 - 21:42 Permalink

China will import more gold to pay for its oil. 

Soon an ounce of gold will be worth 30 - 50 barrels of oil in China but only $ 1300 in America. 

 

AntiBolshevist Sun, 04/29/2018 - 21:55 Permalink

All done by Jews. The theft of American and Western jobs and accompanying wealth that were handed over to China, and India was done by Jews. The bankrupting of the American public, done by Jews. The Communist indoctrination of American youth, by Jews. The corruption of the Media, and Financial industry, all done by Jews. Jews are the reason for the gutting of the West, the war on Whites, the turning of Women into men, and men into Women. The flooding of entitled immigrant trash into Western lands - Ofcourse, done by Jews. All the evidence is there, they cannot help but gloat of it. Hitler was right all along. Jews are the plague, parasites of this planet. Infect the host and destroy it as it becomes aware, now moving onto the next host: China. A country they have been setting up since before the "Cultural Revolution" that they instigated, funded, and ran behind the scenes.

RKae Sun, 04/29/2018 - 22:33 Permalink

On a pointless side note, I utterly HATE the cliche "sea change."

3.) "Sea change."

2.) "Watershed moment."

1.) Referring to a court case as a "slam dunk."

Sorry. Back to pertinent things.

gwar5 Sun, 04/29/2018 - 22:41 Permalink

Its' called competition. Yeah, deficits will matter again but China doesn't exactly want a strong yuan either. 

And we could always use the (fake) gold in Fort Knox to back the USD again and newfound energy exports (coal, gas, oil) makes the USA the new Saudi, whether  priced in Yuan or USD. 

Chinese fire drill.

PettyTyrant Sun, 04/29/2018 - 22:58 Permalink

N.Korea gave up its nukes for free.  China doesnt want that 4.5 trillion on the Feds balance sheet.  Hong Kong is not going to take the Yuan as the HKD Peg.  The cost for switching to a Yuan peg is not exactly 4.5 trillion.   HSBC is the safest bank in the world.   Euro will not loose 10% of ground to Yuan as reserve currency.  and finally but most truthfully,  China is in direct competition with the the USD, not the Euro.

Quantify Sun, 04/29/2018 - 23:21 Permalink

I think what will happen is, it will push technology to create innovations in Energy production that actually work. Which probably isn't solar and certainly isn't wind. Perhaps vast increases in nuclear or a breakthrough in Fusion. 

Ghost who Walks Quantify Mon, 04/30/2018 - 02:05 Permalink

Hi Quantify, I suspect you know more than you've suggested here. I've been waiting to see when the new energy technology gets out into wider use. 

I'm still watching Brilliant Light Power to see how close this is to an introduction http://brilliantlightpower.com/news/

Catherine Austin Fitts has something to say on energy and the economy of the US. https://www.youtube.com/watch?v=bgjLDI0riW8

 

In reply to by Quantify

SnottyBubbles Sun, 04/29/2018 - 23:23 Permalink

Those crazy Swiss! All of 1.2% of global trade is conducted after 3 years of the petro-yuan. China pay in gold? Just how liquid is gold at 5+ claims/oz of gold? I really don't know that sovereign gold at market is liquid at all.

 

Is everyone overlooking that the US just pumped an all-time record avg oil export last week? Anyone look at US reserves of global gold is in US? Fighting the $ just sends cash to the stock market. 

 

 

 

 

besnook Sun, 04/29/2018 - 23:40 Permalink

if china's oil suppliers are all agree to trade their oil for yuan and trade on the chinese oil exchange as a sort of producers exchange (an iranian idea) then there is no problem with confidence in the system. as far as info services and banking i am  sure the chinese don't want or need nonuser traders mucking up the market and i am sure an oil exchange can operate as well as it can without the "liquidity" the zionazi banks will provide.