by JOHN A. MATHEWS & MARK SELDEN
It has long been a goal of the Chinese leadership to see the national currency, the yuan, play a greater role in international finance. The internationalization of the yuan has been pursued through many initiatives and strategies, most recently in relation to the IMF and the inclusion of the yuan in a “basket” of currencies underpinning Special Drawing Rights. Internationalization has doubtless been delayed by relative non-convertibility and China’s state-run financial system, amongst other factors. As matters are liberalized on the financial front, so it becomes more credible for the yuan to play the global role that would be expected of the currency of the world’s largest trading nation, the world’s largest manufacturing nation, and the world’s second largest economy. But the year 2018 has seen a dramatic break with this SDR-focused strategy, and its replacement by a strategy that targets the oil market – the world’s largest commodity market, where trading in US dollars has been near-universal for decades.
This break involves the launch by China of a new oil futures contract on the Shanghai International Energy Exchange (INE). Launched on March 26, 2018, the Shanghai oil futures contract has met with solid market acceptance. It has already overtaken comparable oil futures offerings in both Singapore and Dubai. Of course it still lags in volume terms behind the rival Brent crude oil futures contract traded in London, and the West Texas Intermediate (WTI) oil futures traded in New York. But the very fact that it is being traded seriously by multinational commodity traders (like Glencore) and is priced in a manner that is comparable to the Brent and WTI indices, indicates that this is an initiative with the potential to bring the Chinese yuan to the core of global commodity trading activity.
This article analyzes the significance of the Chinese oil futures contract initiative, creating what is widely known as the “petroyuan”, and sets it in the framework of the broader internationalization of the yuan. It is important not to overstate the significance of this event, as the institutions supporting the US dollar as global currency are still powerful and dominant. China’s prospects have also been dented by the aggressive trade tactics launched by the Trump administration, with a clear focus on China as principal target. The issue is complicated by the re-imposition of US sanctions against Iran, and specifically against Irani oil exports to China (as discussed below). But there is a case to be made for the strategic significance of this Chinese intervention in the commodity markets. Just as the current US financial and industrial hegemony is grounded in the dollar’s exclusivity as vehicle for global oil trading, so the decisive intervention by the Chinese to create a credible alternative in oil could well have the effect of ushering in a new, multipolar world of trade, finance and industry.
The case can be made that earlier Chinese initiatives to internationalize the yuan, such as the widely debated initiative to recast the financial system based on Special Drawing Rights (SDRs), were premature in the absence of widely accepted use of the yuan in commodity trading markets. Now China has taken an apparently well-planned and executed initiative that is focused precisely on the commodity markets, and in particular on oil, the world’s largest traded commodity. The initiative is backed by the gold convertibility of the oil futures contract, creating an important safety valve. The initiative can be viewed as supported by complementary efforts to create a yuan-based trading system in the form of the Belt and Road Initiative and the Asian Infrastructure Investment Bank. These far-sighted measures are coming together at a time when the US is focused inwards on short-term trade measures like imposing punitive tariffs on China and its allies including those in Europe, Canada and Asia, and withdrawing from the Trans Pacific Partnership. But the storm clouds created by the Trump initiatives certainly complicate the picture – particularly the re-imposition of sanctions against Iran and its oil exports.
Oil trading and oil futures
The oil market, currently estimated to be worth $14 trillion, is (as mentioned above) the world’s largest commodity market.1 The current system of oil trading in US dollars dates from an agreement reached in 1974 between the US and House of Saud of Saudi Arabia, to the effect that all purchases of oil from Saudi Arabia would be made in US dollars, and surpluses would be recycled by Saudi Arabia through US financial markets. These terms were extended to encompass all members of the Organization of Petroleum Exporting Countries (OPEC) in 1975. The terms cemented the primacy of the US dollar in world currency, trade and particularly oil trade markets.