The rise of the petroyuan is just a matter of time

AS oil can now be traded with RMB-denominated contracts in Shanghai, the rise of the petroyuan is a matter of time.

In late March, renminbi-denominated oil contracts began trading in the Shanghai International Energy Exchange (INE), for the first time. Although imperial colonies were dismantled over half a century ago, the US dollar (USD), together with the euro (EUR), dominate more than 85 percent of international payments, followed by the English pound, Japanese yen, Swiss franc, Canadian dollar and Chinese yuan.

Yet, as secular stagnation and political divisions constrain US dollar and the euro, the prospects of the Chinese RMB look bright.

China is already the world’s biggest trading country, has the largest foreignexchange reserve, and the world’s biggest consumer market. Now it is integrating into the global financial system.

Since China absorbs most of the world’s commodities, including oil imports, dollar-denominated intermediaries are no longer warranted.

Today the US dollar accounts for 40 percent of international payments while the US share in the world economy is less than half of what it was in 1945.

The US dollar’s coverage is slipping because structural conditions that supported its dominance have been softening since the early 1970s. That’s when Washington decoupled the dollar from gold. And as OPEC agreed to keep oil dollar-denominated, in exchange for security assurances, the petrodollar ensued.

The problem is that as long as emerging and developing economies depend on the US dollar, they remain exposed to US currency risk and US$21 trillion of US sovereign debt, not to speak of US sanctions politics.

Meanwhile, the RMB internationalization has intensified. Last fall, China established a payment system for transactions involving Chinese yuan and Russian ruble. The China Foreign Exchange Trade System hopes to launch similar arrangements with other currencies, especially with countries that represent China’s energy importers and participants of the Belt and Road Initiative. Taken together, these forces are fueling the petroyuan.

As an increasing share of China’s oil imports will be priced in RMB, that will result in large amounts of RMB reserves in oil exporters, which will be spent on Chinese exports, or recycled into China’s financial markets. As demand for RMB assets increases, the role of the USD for trading purposes will lessen.

In the short-term, the Chinese system is unlikely to change the way oil is traded globally. Even with exchange convertibility, international investors and traders must have confidence in Shanghai INE as a trading hub.

The participation of two of the world’s best known commodity trading companies — Glencore and Trafigura — suggests that foreign players are ready for Chinese opportunities, although many are monitoring how the debut exchange operates before joining.

China has a strong record, as evidenced by nickel. It was the last major commodity to be listed in Shanghai in 2015 and had a successful launch. Within six weeks, trading in Shanghai surpassed benchmark futures on the London Metals Exchange.

In the longer term, the petroyuan will mean a huge shift in global asset allocations to China’s financial markets, as long as China continues to remove or significantly reduce capital controls for RMB-priced oil trading.

However, if investors lose faith in the US dollar, the shift away from the US dollar could accelerate dramatically.

Dan Steinbock is the founder of Difference Group. He has served at the India, China and America Institute (USA), the Shanghai Institutes for International Studies and the EU Center (Singapore).