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 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 too 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.