Abstract
President & CEO of RARE PETRO, Anthony D. McDaniels, sat down with Kathryn Mills of The Crude Audacity Podcast to discuss the assault on the PetroDollar LIVE on Facebook and YouTube. It was an energetic discussion on today’s Global Oil Market and what it means for the strength of the American Oilfield, American Energy Security, and American Global Influence. While their conversation was lively, it was not quite long enough to dive deep into the complex intricacies fueling this Oil War.
Background into Petro-Currencies
The Petro-Dollar was created when the U.S. made an agreement in 1974 with Saudi Arabia and other OPEC countries to begin standardizing oil sales in U.S. dollars. This resulted in providing the United States with leverage over anyone selling or purchasing oil since it needed to be done in U.S. currency. Countries had to have U.S. dollar reserves in their financial systems to trade oil which then encouraged further spending for other U.S. goods or Treasury bonds.
In March 2018, China began trading oil futures contracts on the Shanghai INE market in Yuan that are backed by gold. This was the beginning of the Petro-Yuan. Over the last two years, the Petro-Yuan has increased the volume it has been traded, taking oil contract volume away from WTI and Brent futures. This positioning for market share has the same impact for China that the Petro-Dollar created for the U.S. in the 1970’s. As more Petro-Yuan contracts are traded, foreign countries must keep additional Yuan in their financial reserves which in turn incentivizes more foreign trade in the Yuan currency. An additional benefit for some countries is the Petro-Yuan allows oil exporting nations under political pressure or sanctions by the U.S. such as Russia, Iran, and Venezuela to bypass selling oil on through U.S. benchmark or be subject to United States trade laws. This is currently being done by the aforementioned countries and several others.
India is the third largest oil importer behind China and the United States which also gives them incentive on the global stage to trade within their own currency. While crude futures trading in the Petro-Rupee would be a benefit to India going forward, there are several hurdles that need to be achieved for successful implementation. Currently the SPR for India is not exceptionally large and cannot store enough crude inventory to be effective for larger volume contract trading. The country also needs to introduce long-term futures and options to trade to allow for physical delivery of oil similar to WTI and Brent. These types of commodity contracts also need to be implemented for the refined products coming out of India. To be effective, the Petro-Rupee also needs to bring in foreign oil producers to buy and trade the contracts in India’s market. Without considerable foreign trading volume, the contracts are more speculative, and liquidity is needed to establish a new benchmark. While India may have the incentive to trade crude on a Petro-Rupee contract, the government has not been as aggressive as China to position the country for successfully doing this. For this reason, the Petro-Rupee less of a threat to the de-dollarization of crude oil than the Petro-Yuan.
Below are some additional articles explaining the background of the Petro-Dollar, Petro-Yuan, and Petro-Rupee with key quotes or summaries taken from the sources:
Geopolitical Tensions and Implications for the Global Crude Market, RARE PETRO, March 13th, 2020.
- Saudi Arabia and the U.S. signed an agreement in 1974 to trade oil only in dollars. This agreement was later extended to all of OPEC.
- China surpassed the U.S. as larger importer of oil in 2017. In March 2018, the Yuan crude futures were launched to trade in the Chinese national currency on the Shanghai International Exchange (INE).
- Trading volumes of the Petro-Yuan have been increasing since its inception, especially since the U.S. began re-imposing sanctions on Iran. When the U.S. put pressure on countries to also impose sanctions against Iran, China ignored those demands and allowed Iran to continue exporting oil in Yuan.
- Russia has also begun selling oil in Yuan to circumnavigate trading oil in the U.S. dollar.
Petro-Dollar. Petro-Yuan. Petro-Rupee?, Gateway House Indian Council on Global Relations, June 2019.
https://www.gatewayhouse.in/wp-content/uploads/2019/10/PetroDollar-PetroYuan-Petro-Rupee_FINAL.pdf
- For the Petro-Rupee to become relevant, India needs to start inviting private participation in creating an SPR. It can be used to create a vibrant market in oil futures/options and introduce new futures contracts on refined crude products. This is very achievable if the government were to pursue it.
- Foreign players need to be brough into the market, reducing the role of government in the oil sector and hedging the government’s risk from oil prices. This will depend on successful execution and implementation of the above bullet point and the political will of the Indian government to act.
- High oil prices have always hurt India’s growth. Expanding the influence of the Petro-Rupee is a chance to guard against that risk using Indian financial markets.
- “With its economic dynamism, strong growth prospects, political stability and well-regulated financial markets, India can regain its historical position as the economic nerve center of the entire region.”
- “Financial markets with credible benchmarks and standards represent one arena where India can successfully compete against China. It can’t out-build China on infrastructure and it can’t out-spend China on aid, but India’s open markets and rule of law are strong competitive assets that India should fully utilize. If India doesn’t act now, it risks ceding this field, where it has an advantage, to China as well.”
- “If India does act, the Petro-Rupee could become a reality and India will take its rightful place as a leading player in global financial markets, alongside the Petro-Dollar and ahead of the Petro-Yuan.”
Petro Dollar. Petro Yuan. Petro Rupee? – Global Energy Forum 2020, YouTube – Gateway House, January 12, 2020.
- 100 years ago, Indian currency was a global currency. It fell off the map in the 1940’s but since the 1990s, India’s economy has grown, and the Rupee is becoming global currency.
- Indian oil consumption is dramatically growing. By 2040 Indian oil consumption is expected to top 10 million barrels per day.
- Like India, Asian countries have also grown as consumers and the US is no longer highest oil consumer
- “We need an Asian benchmark that mirrors Asian consumption and production patterns”
- India is the best market to create a new market for trading oil commodities, but the Indian economy needs a strategic reserve first.
India can Become a Rule-Maker in the Global Oil Trade Instead of the Rule-Taker it is Today, The Economic Times, January 18, 2020.
- Even though the center of gravity of global oil trade has shifted from the West to Asia, the oil trade is still managed on western exchanges.
- Four of the five top importers — China, India, Japan and South Korea — are in Asia. India is expected to be the major driver of future growth in oil demand at a time when oil consumption in western countries is flat or declining.
China: The Emergence of the Petroyuan and the Challenge to US Dollar Hegemony, The Asia-Pacific Journal, November 15, 2018.
https://apjjf.org/-Mark-Selden–John-A–Mathews/5218/article.pdf
- The Shanghai oil futures contract (Petro-Yuan) has overtaken oil futures offerings in both Singapore & Dubai.
- China’s initiative is backed by the gold convertibility of the oil futures contract.
- The Petro-Yuan is the largest initiative for China, but there are complimentary ones like the Belt and Road Initiative and the Asian Infrastructure Investment Bank. The goal is to create a Yuan-based trading system.
- Chinese-Russian contracts are in Yuan, and Iran, Iraq, Venezuela, and Indonesia also have some contracts in Yuan.
- China’s imports the largest amount of oil from Russia, followed by Saudi Arabia, Angola, Oman, Iraq, and Iran.
- As more countries accept the Petro-Yuan as payment for oil, it adds pressure for countries like Saudi Arabia to also start accepting it.
- The Petro-Yuan contract volumes have been growing compared to WTI. At the end of Sep. 2018, 16% of trades were the Shanghai oil futures while the WTI contract declined from 60% to 52% and Brent fell from 38% to 32%.
- By June 2018, the Belt Road Initiative reached the equivalent of US$5 trillion with the Yuan being the primary monetary vehicle. Trade and investment in Yuan instead of the U.S. dollar promotes Chinese economic growth. It also provides geopolitical influence and soft power while allowing countries to evade U.S. sanctions.
- The grade specifications for futures contracts using the Petro-Yuan are better aligned with Asian oil consumption patterns than Brent and WTI.
Crude Oil Futures Trading Volumes Since Inception – Percent total between WTI, Brent, & Shanghai futures, Reuters, July 2018.
https://fingfx.thomsonreuters.com/gfx/editorcharts/CRUDE-OIL-FUTURES/0H0014BRQ1Y0/index.html
- Chart showing the percentage of monthly trading volumes for contracts on the WTI, Brent, and Petro-Yuan.
Setbacks to the Petro-Yuan
While the Petro-Yuan has been gaining market share since its inception in 2018, there are still several aspects to the commodity contract that make it difficult to trade and foreign investors see as risks. The Chinese government is not very transparent when it comes to futures trading which adds risk for foreign investors. In May 2018, China stopped releasing monthly import/export volumes for crude oil. These are numbers that most major oil producing countries and importing countries release because it helps aid in pricing the commodity. Most of the oil companies in China are also owned by the government. Since the government controls to producing companies and gets to set the price of oil and its refined products, free markets don’t really exist to trade commodity futures. The result of this is investors trading the Petro-Yuan are mostly speculative, and most of the volume for futures contracts are domestic rather than foreign entities. The contracts that are traded are also mostly for the front month because there is no incentive to hedge for future prices when the government is the one manipulating them.
Below are some additional articles explaining some of the setbacks facing large scale utilization of the Petro-Yuan with key quotes or summaries taken from the sources:
China Missed its Moment to Shine in Oil Trading, Nikkei Asian Review, May 6, 2020.
https://asia.nikkei.com/Opinion/China-missed-its-moment-to-shine-in-oil-trading
- The INE contracts were the first oil futures to be traded in China, the world’s biggest oil importer. They were also the first in the country where foreigners and locals settled trades together in Yuan. As an extra incentive, foreign investors won a three-year exemption from taxation on trading profits.
- While trading volumes have been on the rise, the bulk of activity generally takes place in an evening session when U.S. and U.K. markets are busy, indicating perhaps that Shanghai is following, rather than driving, price movements.
- The market has not provided a reference point for Russian and Iranian oil suppliers, who have an interest in avoiding dollar contracts.
- It is difficult for China to be a market leader if they are not open for business. The INE also has less than a third of the oil storage capacity of Cushing, Oklahoma, the delivery point for West Texas contracts. It has already been bumping up against storage limits, though the exchange has announced it will add more capacity.
- Oil contracts have come into the spotlight in China recently, but not those of the INE. Its contracts are off limits to banks as well as to most retail investors, who also cannot directly participate in overseas futures markets due to exchange controls.
- Chinese banks created structured investment products whose value was tied to West Texas oil. When WTI contracts priced below zero, investors saw their investments totally wiped out.
- Nothing is more important for markets than being open for businesses. Whatever the failings of existing international marketplaces, China has yet to provide a viable alternative. The INE has market rules limiting daily price movements initially to 6%, then later to 10%, INE trading has stopped entirely on some of the most volatile days.
What is the Petroyuan?, FXCM.com, March 2018.
https://www.fxcm.com/markets/insights/what-is-the-petroyuan/
- The Petro-Yuan faces many challenges to its longevity and status as an alternative to USD-denominated crude oil.
- “Concerns facing governmental control of the CNY and China’s protectionist economic policies have given the international financial community reasons for pause in the past.”
- Even though the CNY is recognized as a global reserve currency by the International Monetary Fund, skepticism by investors remains.
- “Only time will tell if the petroyuan is to become the new global benchmark for crude oil valuations. Ultimately, it will survive and flourish depending upon its utility, open interest, and traded volumes”
China’s Oil Futures Give New York and London a Run for Their Money, Wall Street Journal, March 27, 2019.
- Even though there has been a surge in volumes, most trading in Yuan-based contracts is domestic rather than foreign.
- In March 2019, the Shanghai contract volume was about 14% of global activity, or half of Brent’s, while the bulk of trading is still WTI contracts.
- Structural issues to China’s oil industry could hinder growth of the Shanghai futures market. This includes the monopoly of state-run producers and government influence on pricing.
- Even if trading volume is large, if not enough foreigners participate, the global influence is limited. A large portion of trading in Shanghai is driven by speculators.
- There is less need for hedging in China because the state has control over the oil industry. The nation’s economic planning agency sets prices for oil products. “This isn’t a free market so why do I need to hedge?”
Below are two figures taken from the WSJ article. The first show a comparison of oil futures prices since the inception of the Yuan compared to WTI and Brent futures. The second figure shows trading volumes for all three contracts over the same period.
Fears that China Will Abandon the Dollar are Greatly Exaggerated (As Usual), Forbes, January 11, 2018.
- From 2005-2017 the US dollar made up 65% of global currency reserves.
- “In the late 1970s, pundits predicted that the Deutschmark would replace the Dollar, then in the late 1980s it was the Yen, and around 2000 it was the Euro. Now it’s the Renminbi. Throughout it all, the Dollar has remained on top.”
Future of the Petro-Yuan and Petro-Dollar
Looking forward, China will continue to position itself to trade more crude in the Petro-Yuan instead of the U.S Dollar. This positioning has already been seen with some of China’s development initiatives for Asia as well as continuing to form agreements with countries to transfer money outside of the jurisdiction of the Federal Reserve. Since the Petro-Yuan is backed by gold, this gives investors the option to convert it on the Shanghai Gold Exchange. Oil producing countries trying to evade U.S. sanctions and other countries doing business with them will continue to rely on the Petro-Yuan to trade commodities. Russia and China have been developing their own international money transfer network to bypass the system in place by the U.S. government. This will make transferring funds between the two countries at the national level much easier.
As the Petro-Yuan gains more traction, oil producers that have operations in China will be better prepared to do business in Asia because they will already have a reserve of Yuan on hand. Other companies that don’t have operations in China and only operate in outlying nations will face more difficulty because they will need to convert currency on the foreign exchange markets in order interact with China and the Petro-Yuan.
A move to price more commodities in the Petro-Yuan will probably not de-throne the U.S. dollar and make the Yuan the new currency for oil. Instead it will slowly chip at the control the U.S. dollar has on oil and gas trading and de-centralize how the dollar is used to price energy. This will open the door for other nations to begin trading oil in their own currency and the greenback will no longer have the same stronghold on oil price that was created in the 1970’s. As a result, this will allow countries like China holding a large portion of U.S. Treasury debt to reduce their reliance on the U.S. dollar and create more leverage at the geopolitical level.
Below are some additional articles explaining what may happen to the Petro-Yuan in the future and how it may influence further “de-dollarization” of U.S. currency. Key quotes or summaries taken from the associated sources:
Could the Oil Price War Force U.S. Antitrust Laws on Saudi?, RARE PETRO, April 2, 2020.
- In March when Russia and Saudi Arabia began the oil price war, the U.S. threatened to enact the NOPEC bill. This would allow the United States Justice Department to sue OPEC for distorting the free market on crude prices.
- It is unlikely the U.S. will enact any antitrust laws against Saudi Arabia. If the bill was enacted, it may lure Saudi Arabia away from continuing to trade in U.S. dollars and begin trading for the Yuan.
Shanghai Energy Exchange Adds to Sinopec Crude Oil Warehouse Capacity, Reuters, May 12, 2020.
https://af.reuters.com/article/commoditiesNews/idAFL4N2CU2FQ
- The energy exchange has been increasing its total warehouse capacity for crude oil futures in the past month, following a Reuters report that traders, seeking to exploit a price anomaly by delivering crude into Shanghai crude futures contracts, were thwarted by a lack of available space.
- Storage capacity at the Sinopec petroleum Commercial Reserve will be increased from 700,000 to 800,000 cubic meters.
How Petrodollars Affect the U.S. Dollar, Investopedia, April 21, 2020.
https://www.investopedia.com/articles/forex/072915/how-petrodollars-affect-us-dollar.asp
- There are concerns of a shift away from Petro-Dollars to other currencies.
- Venezuela said in 2018 that it would begin selling its oil in the Yuan, Euro, and other currencies.
- In 2019 Saudi Arabia threatened to abandon Petro-Dollars if the U.S. moved forward with NOPEC. This bill would allow the U.S. Justice Department to pursue antitrust action against OPEC for manipulating oil prices.
- Changes in the global energy market could result in a de-facto end to the U.S.-Saudi Petro-Dollar agreement.
Will the Dollar Survive the Petro-Yuan?, OilPrice.com, March 2018.
https://oilprice.com/Energy/Energy-General/Will-The-Dollar-Survive-The-Petro-Yuan.html
- “The dollar’s role as the legacy trade medium is no longer appropriate, given that China’s trade is now driving the global economy, not America’s.”
- “By cutting a deal with the Saudis in 1974, Nixon and Kissinger ensured that all energy, and in consequence all other commodities, would continue to be priced in dollars.”
- “Until very recently, most of the world was America’s monetary colony, and in that context, she is losing Asia, the Middle East, and some countries in Africa as well. The territory that offers fealty to the dollar is definitely contracting, just as it did for the German mark after 1918, and as it did for the Austro-Hungarians, whose Austrian crown suffered a similar fate.”
Precious Metals Premiums, the COMEX and the Macro Picture, Streetwise Reports, April 22, 2020.
https://www.streetwisereports.com/article/2020/04/22/precious-metals-premiums-the-comex-and-the-macro-picture.html – (Search for the term “yuan” in the article and read the associated three paragraphs)
- China pays for oil and gas in a bond denominated in Yuan that is then immediately convertible into gold on the Shanghai Gold Exchange.
- The Shanghai Gold Exchange has delivered over 90 times more gold than the COMEX has delivered in the past two years. “You’re seeing countries try to usurp the dollar in trade agreements, in purchasing energy, setting up a system that usurps the SWIFT system, which is if you transact in dollars, you have to be in the SWIFT system.”
China, Russia, & India Push Forward on SWIFT Alternative, FXEmpire.com, November 29, 2019.
https://www.fxempire.com/news/article/china-russia-india-push-forward-on-swift-alternative-616301
- Russia developed an alternative financial messaging system in 2014, and China plans to connect its CIPS system to bypass the SWIFT international money transfer network.
- India is looking to join the network since they don’t have a domestic messaging system.
- SWIFT is currently working on improvements to implement by the end of 2020.
Some U.S. Oil Companies Are Prepared for the Petroyuan – and Some Aren’t, Motley Fool, December 10, 2019.
https://www.fool.com/investing/2019/12/10/petroyuan-which-us-oil-companies-are-prepared.aspx
- Oil-producing nations exporting to China with stockpiles of Yuan on hand will make it easier for them to buy other Chinese goods.
- Russia has overtaken Saudi Arabia as China’s largest oil supplier and extended its international trade with China in Yuan. The July 2019 report said there are over $100 billion annual Chinese-Russian transactions without using the medium of the USD.
- Large companies like Exxon and Chevron that have chemical/downstream operations in China are better positioned to pay for upstream operations in Southeast Asian countries with Yuan.
- Companies without a presence in China (like Hess operating in Malaysia) will have higher costs if Southeast Asian countries start requiring payment in Yuan because the companies would have to go through foreign exchange markets.
UBS: The Petroyuan Will Undermine America’s Dominant Role and Create a Sea Change in Global Markets, Investing Channel, April 29, 2018.
- Seven oil grades became tradeable on the Shanghai International Energy Exchange as of March 26th, 2018.
- For exporters like Russia, Venezuela, Iraq, Iran, and Saudi Arabia, if oil is imported to China in Petro-Yuan the result will be large reserves of RMB in the exporting countries. This allows those countries to spend more on Chinese exports or recycle it back into China’s financial markets instead of the U.S. The result will be increased demand for RMD assets and switching out of USD for trading purposes. Globally the asset allocation to China’s financial markets will shift, undermining the U.S. role in global economy.
- “The 2008 Financial crisis taught the globe an over-reliance on commodities priced in USD can be risky. As China surpassed the U.S. as the largest oil consumer, it wanted to de-risk supply security for energy and also play a greater role in global politics/economy.”
- “When China begins importing commodities in RMB it will create reserves in exporting countries that will be used in China’s financial market with the end result of providing additional leverage to China in the global economy.”
- To create a shift in the global oil market China must:
- Remove/reduce capital controls for RMB-priced oil trading to allow global commodity trading houses access to the INE.
- Come to an agreement with their oil trading partners to accept RMB for oil exports to China. Russia and Iran already do this. Other countries sanctioned by the U.S. may be doing this or considering it.
- Global institutional investors increased China holdings of onshore bonds threefold between Jan 2014-Dec 2017.
A “Growing Club” of “Very Powerful Countries” is Steering Away from Using the Dollar, CNBC, October 30, 2019.
- Major countries have been pushing to do more transactions outside of the USD because when the transactions clear through an American bank it is subject to U.S. jurisdiction.
- Some European countries wanting to do business with Iran after the U.S. withdrew from the nuclear deal in 2018 were open to punishment by the U.S. if they continued doing business with Iran.
- The Petro-Yuan is the first mover showing the globe shifting away from the U.S. dollar. Oil trading alone in Petro-Yuan is not enough to create an international abandonment of the dollar, but it may be a precursor for future “de-dollarization.”
Could China and Russia Abandon the US Dollar and Forge A Yuan-Rouble Deal?, South China Morning Post, January 15, 2019.
- Russia and China have been working to finalize a system that they both agree on which allows them to transition away from the US dollar
- It has been especially difficult to develop a system that replaces the US dollar.
- Since the US has remained in an adversarial position to both the Rouble and Yuan, the strategic partnership between Russia and China will grow. Many countries have the common goal of escaping the US’s jurisdiction.
The Dollar won’t Always be King of Currency. Other Countries Want to Topple It, The Washington Post, June 13, 2019.
- A lot of desire to get away from the U.S. dollar comes because of the Trump Administration abusing its trade power.
- Trump has abused tariffs by aiming to block the trade of things like cars and phones in the name of “national security” which frightens the countries that are dependent on U.S. technologies with U.S. dollar debts. This subjects them to U.S. powers should they do anything to challenge the U.S.
- Abuse of power is the primary reason people are looking to abandon the dollar.
- “Consider the trigger for this search for an alternative to the dollar. Britain, France and Germany are all signatories to the 2015 Iran nuclear deal. When the Trump administration unilaterally reneged on the pact last year — even though Iran had abided by it — the United States reimposed sanctions, using its dollar power to prevent other countries from doing business with Iran.”
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