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Irina Slav

Irina Slav

Irina is a writer for the U.S.-based Divergente LLC consulting firm with over a decade of experience writing on the oil and gas industry.

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Chinese Oil Futures Remain High-Risk Endeavour

When the long-awaited yuan-denominated oil futures launched earlier this year, opinions were split: one camp argued with passion that the days of the petrodollar were numbered, its demise a certainty. The other camp argued with just as much passion the yuan has yet to catch up with the dollar as an international currency, and the Chinese futures had basically as much of a chance as a snowflake in Hell.

Now, six months later, opinions remain split, but now the two camps have some facts and figures in their arsenal. For example, a figure for the pro-petroyuan camp was the record surge in trading volume in June, to 137.5 million tons of crude for delivery in September. This translates into 137,503 lots, compared to a combined 2.6 million lots for Brent and WTI together, though, so the yuan contract still has a way to go to catch up.

The anti-petroyuan camp, however, seems to have a bit more going for it after six months of trade. Bloomberg cites traders as saying that the exchange rate of the yuan coupled with storage costs make the Chinese oil contract still a high-risk endeavor.

The yuan has been falling in recent months on the back of slowing economic growth and the tariff spat with the United States. There is a lot of space for surprises, however, and unpredictability is not something low-risk traders like, so exchange rates are one thing that could put them off the yuan contract.

Storage costs in China are another problem. They are much higher than elsewhere: US$0.95 per barrel per month in the Shanghai International Energy Exchange compared with US$0.05 per barrel per month at the Louisiana Offshore Oil Port, Bloomberg reports. The reason for the higher cost is limited storage capacity availability and the requirement that the cargo be stored at a specific storage facility rather than at any available. Related: The “Weakest” EIA Report In Years

So, in light of these unpleasant facts, what does the yuan-denominated futures contract have going for them? Well, apparently, they could make sellers richer than if they choose to trade Middle East grades. The yuan contract last week traded at a considerable premium to all other oil futures, with the premium to the Middle East benchmark at US$3.35 per barrel. That makes a profit of US$6.7 million for a cargo, according to Bloomberg calculations—certainly not a small sum. But is it worth all the risks?

Perhaps it is and perhaps it isn’t, but it looks like it is still too early to say. The seriousness of the risks, after all, is relative. This was evidenced in the record-high trading interest in yuan futures in early June that some observers, quoted by S&P Global Platts, attributed to the heightened price volatility in the Brent and WTI benchmarks. On the other hand, storage costs are a fixed problem that is not about to go away. It’s a risk that traders have probably already learned to factor into their calculations. Exchange rates are another cesspool of volatility, but volatility is a double-edged sword. Economic data from China may still surprise positively as it has before, despite the tariffs.

Ultimately, however, the question of whether the petrodollar will be replaced by the petroyuan is moot. The reason for this is simple: the dollar is the international reserve currency because most oil is traded in dollars, says international relations professor and China expert Douglas Bulloch. It is the international reserve currency because of the size and nature of the U.S. economy. Therefore, the only way for China to succeed in having its currency stand a fighting chance against the greenback is to continue opening up its economy. Oil trading is only part of that.

By Irina Slav for Oilprice.com

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  • Mamdouh G Salameh on August 21 2018 said:
    I have always argued that the imposition of US tariffs on Chinese goods could be the first shots in the petro-yuan/petrodollar war of attrition. The launching of the crude oil benchmark on the Shanghai exchange could mark the beginning of the end of the petrodollar. The United States is not going to take this potential threat lying down.

    Like any major project in the world, there is always an element of risk. However, the petro-yuan has a lot going for it. China is the number one exporter on the globe, the world’s largest crude oil importer and also the world’s biggest economy estimated at $25.24 trillion in 2018 based on purchasing power parity (PPP) compared with $20.41 trillion for the US. And while the petrodollar is backed by Treasuries, the petro-yuan, on the other hand, is backed by gold.

    Moreover, the petro-yuan can currently bank on 21.6 million barrels a day (mbd) or 32% of global oil trade. This is made up of Russian, Iranian and Venezuelan oil exports and Chinese oil imports. At a price of $72 a barrel, this means that more than $568 bn of the oil trade is now done in petro-yuan. This figure goes much higher when we add Asian crude oil contracts that are traded in the petro-yuan.

    In less than three months since its launch, trading volumes in the petro-yuan surged in June 2018 to 137,503 lots for delivery in September or 5.29% of the volumes traded in both Brent and WTI together. While the petro-yuan has a way to go to catch up, it is probable that it will dominate the global oil trade within the next decade and will emerge as a top international reserve currency.

    Dr Mamdouh G Salameh
    Intwrnational Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • Muhammad_Aidid on August 22 2018 said:
    95 cents storage fee per barrel is reasonable rate. 5 cents per barrel is too cheap unless it's not a real barrel of crude oil, just contract paper without oil backing it. Petro-yuan is more legitimate since the storage rate prevents speculation and focus more on real and honest trading of commodities.

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