On March 26 China will finally launch a yuan-dominated oil futures contract. Over the last decade there have been a number of “false-starts,” but this time the contract has gotten approval from China’s State Council.
With that approval, the “petroyuan” will become real and China will set out to challenge the “petrodollar” for dominance. Adam Levinson, managing partner and chief investment officer at hedge fund manager Graticule Asset Management Asia (GAMA), already warned last year that China launching a yuan-denominated oil futures contract will shock those investors who have not been paying attention.
This could be a death blow for an already weakening U.S. dollar, and the rise of the yuan as the dominant world currency.
But this isn’t just some slow, news day “fad” that will fizzle in a few days.
A Warning for Investors Since 2015
Back in 2015, the first of a number of strikes against the petrodollar was dealt by China. Gazprom Neft, the third-largest oil producer in Russia, decided to move away from the dollar and towards the yuan and other Asian currencies.
Iran followed suit the same year, using the yuan with a host of other foreign currencies in trade, including Iranian oil.
During the same year China also developed its Silk Road, while the yuan was beginning to establish more dominance in the European markets.
But the U.S. petrodollar still had a fighting chance in 2015 because China’s oil imports were all over the place. Back then, Nick Cunningham of OilPrice.com wrote…
Despite accounting for much of the world’s growth in demand in the 21st Century, China’s oil imports have been all over the map in recent months. In April, China imported 7.4 million barrels per day, a record high and enough to make it the world’s largest oil importer. But a month later, imports plummeted to just 5.5 million barrels per day.
That problem has since gone away, signaling China’s rise to oil dominance…
The Slippery Slope to the Petroyuan Begins Here
The petrodollar is backed by Treasuries, so it can help fuel U.S. deficit spending. Take that away, and the U.S. is in trouble.
It looks like that time has come…
(Click to enlarge)
A death blow that began in 2015 hit again in 2017 when China became the world’s largest consumer of imported crude…
Now that China is the world’s leading consumer of oil, Beijing can exert some real leverage over Saudi Arabia to pay for crude in yuan. It’s suspected that this is what’s motivating Chinese officials to make a full-fledged effort to renegotiate their trade deal.
So fast-forward to now, and the final blow to the petrodollar could happen starting on March 26. We hinted at this possibility back in September 2017…
With major oil exporters finally having a viable way to circumvent the petrodollar system, the U.S. economy could soon encounter severely troubled waters.
First of all, the dollar’s value depends massively on its use as an oil trade vehicle. When that goes away, we will likely see a strong and steady decline in the dollar’s value. Related: China’s Gas Storage Capacity Can’t Keep Up With Demand Growth
Once the oil markets are upended, the yuan has an opportunity to become the dominant world currency overall. This will further weaken the dollar.
The Petrodollar’s Downfall Could be a Lift for Gold
Amongst all the trouble ahead for the dollar, there are some good news too. The U.S. might have ditched the gold standard in the 1970’s, but with gold making a return to world headlines… we could see a resurgence.
For the first time since our nation abandoned the gold standard decades ago, physical gold is being reintroduced to the global monetary system in a major way. That alone is incredibly good news for gold owners.
A reintroduction of gold to the global economy could result in a notable rise in gold prices. It’s safe to assume exporters are more likely to choose a gold-backed financial instrument over one created out of thin air any day of the week.
Soon after, we could see more and more nations jump on the bandwagon, resulting in a substantial rise in gold prices.
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On Monday the 26th of March 2018, China will finally launch a yuan-dominated oil futures contract backed by gold. This will mark the most momentous turning point for the US economy and the petrodollar and also for China’s status as an economic superpower.
Right now, China is the number one exporter on the globe, the largest crude oil importer in the world and also the world’s largest economy with a GDP of $23.57 trillion in 2017 (compared to $19.36 trillion for the US), based on purchasing power parity (PPP).
Since the early 1970s, the global oil trade has almost entirely been conducted in petrodollars. Moving oil trade out of the petrodollar into the petro-yuan will take initially between $600 billion and $800 billion worth of transactions out of the petrodollar. Maintaining the petrodollar is America’s primary goal. Everything else is secondary.
The petrodollar system provides at least three immediate benefits to the United States. It increases global demand for US dollars. It also increases global demand for US debt securities and it gives the United States the ability to buy oil with a currency it can print at will. In geopolitical terms, the petrodollar lends vast economic and political power to the United States.
China hopes to replicate this dynamic. A rising China is eyeing the benefits of having its own currency play a larger role and supplant the petrodollar in global trade. The initial focus of that trade is oil trade.
The petrodollar is backed by Treasuries, so it can help fuel US deficit spending. Take that away, and the US economy will be in trouble leading to a strong and steady decline in the dollar’s value.
But it won’t be easy to unseat the petrodollar without the participation of some major oil producers like Russia and Saudi Arabia. Between them Saudi Arabia and Russia account for 26% of global oil production and 25% of oil exports. Russia is already on board along with Iran and Venezuela.
China is now trying to persuade Saudi Arabia to start accepting the yuan for its crude oil. If the Chinese succeed, other oil exporters could follow suit. For Saudi Arabia, it will find itself between a rock and a hard place – lose the Chinese oil market or spark the ire of Washington.
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.
The imposition of tariffs on Chinese goods could be the first shot in the petro-yuan/petrodollar war of attrition. President Trump is trying, in my opinion, to provoke a showdown with China in order persuade it not to launch its crude oil futures contract. The United States will be trying to bargain away the tariffs for the withdrawal of the crude oil futures contract. However, China has attached so much prestige to its crude oil futures contract so it is unthinkable it will agree to withdraw it, hence the impending trade war between the two countries and a possible wider conflict beyond that.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London
Of course US oil imports are down compared to China; the US is drilling a ton of oil these days and will soon overtake Russia as the world's top oil producer. Doom and gloom?
Furthermore, China is not the leading consumer of oil as this article states. They are the leading importer. The US doesn't need to import nearly as much as they used to since they can make it themselves.
Electric vehicle adoption will also impact the significance of the petrodollar. There are talks of China requiring all new cars to be electric within the next decade. This would have a huge impact on the oil market.
What the rise of Russia in cryptos means is that even with sanctions imposed by the U.S. and the E.U., Russia will have a way to send and receive money. The U.S. Treasury Terrorism and Financial Intelligence unit can put sanctioned individuals on a blacklist that keeps them from doing business in U.S. dollars but since cryptos aren’t controlled by any state, it is easy to bypass any blacklist. But, the bigger picture is how it is challenging the global banking system. Disruption is inevitable, and cryptos could become the new driver of international business and financial transactions, and that will all start with trying to destroy the value of the U.S. dollar in trade relations and by using cryptos backed by oil and other natural resources. The U.S. and the U.S. dollar is on bended knee right now. China and Russia are moving to gold backed currency and each has issued home currency-denominated bonds in each other’s markets which will reduce the volatility of yuan and ruble exchange rates. There is an emergence of an eastern gold standard with natural resource-backed crypto kickers in the making. The U.S. dollar is dying.
However with growing clout o Chinese manufacturing and China surpassing USA as leading exporter, the Petrodollar is now at threat. However, there is still a few things which give the edge to USA. The USA and its allies are the largest supplier o food to the Arabs which give the USA a massive leverage over Arabs. In addition, the security apparatus of USA due to years of working is very strong across the world. The CIA has lot of clout in the middle east and can shake things up. Also, the arms and infrastructure of middle east depends on the USA.
Mere manufacturing and export clout of China may be insufficient to make Arabs to switch to Yuan. In addition, the large reserves of dollars with various countries may upset the global order if dollar ceases to be a valuable asset as it is today.
However, on the flip side, USA has antagonised Iran, Russia and even the Arabs by sanctions and Arab Spring. Russia and Iran may side with China in selling its oil in Yuan as a result.. That will itself cause a shake up of about 18 mbpd production being diverted into Yuan. The export in this will be about 10mbpd.
Indians are so funny, they will go to any extent to support their love father US, as it gives them H1b visas every year.