China sees new world order with oil benchmark backed by gold
Yuan-denominated contract will let exporters circumvent US dollar
DAMON EVANS, Contributing writer
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| Yuan-denominated gold futures have been traded on the Shanghai Gold
Exchange since April 2016 as part of the country's effort to reduce the
pricing power of the U.S. dollar.
© Imaginechina/AP Images
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DENPASAR, Indonesia -- China is expected shortly to launch a crude
oil futures contract priced in yuan and convertible into gold in what
analysts say could be a game-changer for the industry.
The
contract could become the most important Asia-based crude oil
benchmark, given that China is the world's biggest oil importer. Crude
oil is usually priced in relation to Brent or West Texas Intermediate
futures, both denominated in U.S. dollars.
China's move will allow
exporters such as Russia and Iran to circumvent U.S. sanctions by
trading in yuan. To further entice trade, China says the yuan will be
fully convertible into gold on exchanges in Shanghai and Hong Kong.
"The
rules of the global oil game may begin to change enormously," said Luke
Gromen, founder of U.S.-based macroeconomic research company FFTT.
The
Shanghai International Energy Exchange has started to train potential
users and is carrying out systems tests following substantial
preparations in June and July. This will be China's first commodities
futures contract open to foreign companies such as investment funds,
trading houses and petroleum companies.
Most of China's crude
imports, which averaged around 7.6 million barrels a day in 2016, are
bought on long-term contracts between China's major oil companies and
foreign national oil companies. Deals also take place between Chinese
majors and independent Chinese refiners, and between foreign oil majors
and global trading companies.
Alan Bannister, Asia director of
S&P Global Platts, an energy information provider, said that the
active involvement of Chinese independent refiners over the last few
years "has created a more diverse marketplace of participants
domestically in China, creating an environment in which a crude futures
contract is more likely to succeed."
China has long wanted to
reduce the dominance of the U.S. dollar in the commodities markets.
Yuan-denominated gold futures have been traded on the Shanghai Gold
Exchange since April 2016, and the exchange is planning to launch the
product in Budapest later this year.
Yuan-denominated gold
contracts were also launched in Hong Kong in July -- after two
unsuccessful earlier attempts -- as China seeks to internationalize its
currency. The contracts have been moderately successful.
The
existence of yuan-backed oil and gold futures means that users will have
the option of being paid in physical gold, said Alasdair Macleod, head
of research at Goldmoney, a gold-based financial services company based
in Toronto. "It is a mechanism which is likely to appeal to oil
producers that prefer to avoid using dollars, and are not ready to
accept that being paid in yuan for oil sales to China is a good idea
either," Macleod said.
Yuan-denominated
gold contracts have significant implications, especially for countries
like Russia and Iran, Qatar and Venezuela, said Louis-Vincent Gave,
chief executive of Gavekal Research, a Hong Kong-based financial
research company.
These countries would be less vulnerable to
Washington's use of the dollar as a "soft weapon," if they should fall
foul of U.S. foreign policy, he said. "By creating a gold contract
settled in renminbi [an alternative name for the yuan], Russia may now
sell oil to China for renminbi, then take whatever excess currency it
earns to buy gold in Hong Kong. As a result, Russia does not have to buy
Chinese assets or switch the proceeds into dollars," said Gave.
Grant
Williams, an adviser to Vulpes Investment Management, a Singapore-based
hedge fund sponsor, said he expects most oil producers to be happy to
exchange their oil reserves for gold. "It's a transfer of holding their
assets in black liquid to yellow metal. It's a strategic move swapping
oil for gold, rather than for U.S. Treasuries, which can be printed out
of thin air," he said.
Market share
China has been
indicating to producers that those happy to sell to them in yuan will
benefit from more business. Producers that will not sell to China in
yuan will lose market share.
Saudi Arabia, a U.S. ally, is a case
in point. China proposed pricing oil in yuan to Saudi Arabia in late
July, according to Chinese media. It is unclear if Saudi Arabia will
yield to its biggest customer, but Beijing has been reducing Saudi
Arabia's share of its total imports, which fell from 25% in 2008 to 15%
in 2016.
Chinese oil imports rose 13.8% year-on-year during the
first half of 2017, but supplies from Saudi Arabia inched up just 1%
year-on-year. Over the same timeframe, Russian oil shipments jumped 11%,
making Russia China's top supplier. Angola, which made the yuan its
second legal currency in 2015, leapfrogged Saudi Arabia into second spot
with an increase of 22% in oil exports to China in the same period.
If
Saudi Arabia accepts yuan settlement for oil, Gave said, "this would go
down like a lead balloon in Washington, where the U.S. Treasury would
see this as a threat to the dollar's hegemony... and it is unlikely the
U.S. would continue to approve modern weapon sales to Saudi and the
embedded protection of the House of Saud [the kingdom's ruling family]
that comes with them."
The alternative for Saudi Arabia is equally
unappetizing. "Getting boxed out of the Chinese market will
increasingly mean having to dump excess oil inventories on the global
stage, thereby ensuring a sustained low price for oil," said Gave.
But
the kingdom is finding other ways to get in with China. On Aug. 24,
Saudi Vice Minister of Economy and Planning Mohammed al-Tuwaijri, told a
conference in Jeddah that the government was looking at the possibility
of issuing a yuan-denominated bond. Saudi Arabia and China have also
agreed to establish a $20 billion joint investment fund.
Furthermore,
the two countries could cement their relationship if China were to take
a cornerstone investment in the planned initial public offering of a 5%
state in Saudi Aramco, Saudi Arabia's national oil company. The IPO is
expected to be the largest ever, although details on the listing venue
and valuation are yet scant.
If China were to buy into Saudi
Aramco the pricing of Saudi oil could shift from U.S. dollars to yuan,
said Macleod. Crucially, "if China can tie in Aramco, with Russia, Iran
et al,
she will have a degree of influence over nearly 40% of global
production, and will be able to progress her desire to exclude dollars
for yuan," he said.
"What is interesting is that China's
leadership originally planned to clean up the markets next year, but
brought it forward to this year. One interpretation of that change is
that they have brought forward the day when they pay for oil in yuan,"
said Simon Hunt, a strategic adviser to international investors on the
Chinese economy and geopolitics.
China is also making efforts to
set other commodity benchmarks, such as gas and copper, as Beijing seeks
to transform the yuan into the natural trading currency for Asia and
emerging markets.
Yuan oil futures are expected to attract interest from investors and funds, while state-backed oil majors, such as
PetroChina and
China Petroleum & Chemical (Sinopec)
will provide liquidity to ensure trade. Locally registered entities of
JPMorgan, a U.S. bank, and UBS, a Swiss bank, are among the first to
have gained approval to trade the contract. But it is understood that
the market will be also open to retail investors.
