By Damon Evans
Nikkei Asian Review, Tokyo
Friday, September 1, 2017
https://asia.nikkei.com/Markets/Commodities/C...orld-order-w...
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.
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
percent in 2008 to 15 percent in 2016.
Chinese oil imports rose 13.8 percent year-on-year during the first half
of 2017, but supplies from Saudi Arabia inched up just 1 percent
year-on-year. Over the same time frame, Russian oil shipments jumped 11
percent, 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 percent 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 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 percent 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 percent 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 also will be open to retail investors.
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