In late March 2018, the global trade of crude oil recognised a new entrant to the marketplace. A product denominated in the Chinese yuan renminbi (CNY, RMB) known as the "petroyuan" was launched on the Shanghai International Energy Exchange (INE). The first of its kind, the product was the culmination of 25 years of development and persistence.
The decade-long growth experienced by China's economy and equities markets prompted the country's government to present the CNY as an international currency. The advent of the petroyuan is widely viewed as an important step in achieving this objective.
The Petroyuan Defined
Upon China overtaking the United States as the world's largest importer of oil in September 2013, new pressures began to mount for a domestic crude oil futures market. The result was the creation of the petroyuan, an instrument many industry experts predict will have "tremendous geopolitical and financial consequences."
The petroyuan is a standardised futures contract available for trade on the Shanghai International Energy Exchange (INE). It is based on the underlying asset crude oil, denominated in CNY per barrel. The contract specifications are as follows:
|Product||Medium Sour Crude Oil|
|Quantity||1000 barrels per lot|
|Price Quote||RMB per barrel|
|Tick Size||0.1 RMB per barrel|
In comparison to the existing benchmarks for global crude oil futures, the petroyuan is unique in several ways:
- Grade: Crude oil is graded primarily according to gravity and sulfur content. The lighter the oil and and the less sulfur it contains, the more desirable it is to refiners. The petroyuan is based on medium sour crude, not the light sweet crude of the West Texas Intermediate (WTI) and North Sea Brent (Brent) contracts. This is a key distinction due to the difference in value between the two grades. Light sweet crude typically receives a US$15 per barrel premium over sour crude as it is more readily refined into premium fuel products.
- Denomination: The petroyuan is denominated in CNY per barrel, while WTI and Brent crude are valued in terms of United States dollars (USD).
While the name petroyuan explains the status of the contract's denomination, a key challenge exists in relation to convertibility. The CNY faces acceptance issues on an international scale due to strong controls from China's government. It is not universally accepted or freely exchanged on the foreign currency markets.
In order to make the petroyuan attractive to investors outside of China, it is backed by gold. Although priced in terms of CNY, proceeds are fully convertible to gold on exchanges in Shanghai and Hong Kong. The petroyuan being gold-backed serves as reassurance to foreign entities who may be interested in trading the contract but are concerned about the transition out of the CNY.
The International Crude Oil Derivatives Trade
Many analysts, investors and traders predict that the petroyuan may become an eventual rival to traditional crude oil derivatives products. While this is certainly a possibility down the line, the trade of WTI, Brent and associated contract-for-difference (CFD) products dominate the vast majority of the crude oil derivatives trade.
The following are the primary means of engaging the international crude oil markets:
- WTI: The global benchmark for the trade of light sweet crude oil futures, WTI is listed on the New York Mercantile Exchange (NYMEX) and offered for trade on the Chicago Mercantile Exchange (CME) Globex electronic platform.
- Brent: Brent crude represents offshore "waterborne" oil production of the North Sea region. Since its inception in the late 1980s, Brent has been viewed as the prominent international oil futures product. It is listed for trade on the Intercontinental Exchange (ICE).
- USOIL: USOIL is a popular CFD offered for trade in an over-the-counter (OTC) capacity. The pricing of USOIL is based on the WTI crude oil futures contract.
- UKOIL: UKOIL is a CFD based on the pricing of the Brent crude oil futures. It is traded OTC in the same fashion as conventional forex products.
To a lesser extent, crude oil futures are also traded on the Dubai Mercantile Exchange (DME). Offered in partnership with the CME, regional producers as well as speculators are able to trade oil futures on the DME. However, DME products offer much smaller volumes than their counterparts on the CME or ICE.
China's Dependence Upon Crude Oil Imports
Over the past several decades, the economic growth experienced by China has made it a financial superpower. Since 1978, China has an average annual growth rate of 9.8%. This explosive expansion has been reliant upon energy consumption, growing by an average of 5.8% annually for the same period.
The availability of energy products, both foreign and domestic, has been vital to sustaining the robust performance metrics of the Chinese economy. With studies estimating domestic production to peak in 2018, the impetus on petroleum imports is likely to intensify in coming years.
For 2016, China imported in the neighborhood of 7.6 million barrels of crude oil per day. The top ten leading exporters of crude to China for the same period are as follows:
|Country||Percent of Total Imports|
|United Arab Emirates||3.3%|
Several of China's leading suppliers face intense scrutiny and economic sanctions from the United States. Russia, Iran and Venezuela have faced formidable regulatory challenges to their energy export sectors. As a result, the countries of BRICS (Brazil, Russia, India, China, South Africa) and Venezuela have officially shown support for the petroyuan throughout the runup to its launch.
A Challenge To The Petrodollar
One of the premier goals of the petroyuan is to become the preferred mode of trade for energy derivatives in the far East. Through the petroyuan, China may effectively challenge the existing petrodollar system of oil valuation.
A "petrodollar" is defined as being any U.S. dollar that is earned from the sale of oil. It may constitute operating capital that is reinvested into the production of petroleum products, or surplus funds used to promote domestic economic prosperity.
Dating back to its inception in the early 1970s, the petrodollar has existed as the primary structure of the global oil trade. Producing nations, primarily in the Middle East, have exported petroleum to developed economies led by the United States, Japan and the countries of the European Union.
The Organisation of Petroleum Exporting Countries (OPEC) has been a key player in the petrodollar, influencing pricing on an ongoing basis. In addition, OPEC nations are involved in "recycling" petrodollars into the world's financial system through the purchase of debt instruments from American and European commercial banks.
The existing petrodollar system places emphasis on the relative strength of the USD. In the event that the USD gains or loses value, the global pricing of crude oil is affected accordingly. The impact of monetary policy decisions rooted at the U.S. Federal Reserve (FED) can be severe on oil importing and exporting nations. As the USD faces inflationary or deflationary pressures, the purchasing power of revenues generated by oil-based economies may fluctuate dramatically.
As the world's largest importer of crude oil, China is particularly vulnerable to the petrodollar system. Imports are denominated in dollars, meaning transactions are beholden to ongoing CNY/USD valuations. When China imports from a leading source such as Saudi Arabia, Angola, Russia or Oman, the USD plays a dominant role in both purchasing power and convertibility.
Being able to conduct business exclusively in CNY, without first having to transition to the USD, is an attractive alternative not only to China but to many leading exporters. Countries facing sanctions, regional trade partners or foreign production companies may find the petroyuan useful in limiting risk exposure to the USD.
The petroyuan 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 recognised as a global reserve currency by the International Monetary Fund, skepticism 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.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…