The Tell: Are we entering the age of the ‘petro-yuan’?

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Most of the world’s commodity trading is denominated in U.S. dollars, but the Chinese yuan, also known as renminbi, could soon be making some inroads.

Reports say that Saudi Arabia—the world’s largest oil exporter—might start to accept Chinese yuan USDCNY, +0.0815%  as payment for its usually dollar-denominated oil exports to China, after oil companies in Russia, Iran and Venezuela have done the same, according to Sue Trinh, head of Asia FX strategy at RBC.

This fuels the specter of a “petro-yuan” taking on the dominance of the petrodollar DXY, +0.09%

RBC Capital Markets, SWIFT

The U.S. dollar and the euro have been dominating the global oil market

“Related to this are reports that China has offered to buy 5% or more of Saudi Aramco directly and that China is preparing to launch a crude oil futures contract denominated in yuan, to be run by the Shanghai International Energy Exchange,” Trinh wrote in a note on Friday.

Saudi Aramco, Riyadh’s national petroleum business, is expected to become a publicly listed company in the near future, and could raise as much as $100 billion.

“There is great difficulty in yuan becoming a petro-/major reserve currency,” Trinh cautioned, while arguing that it could make strategic sense for Saudi Arabia to sell some of its oil in China’s currency.

China’s crude oil consumption has been on the rise. That said, the U.S. and Europe still outweigh China in terms of demand, so it makes sense that petro-payments are weighted toward the dollar and, to a lesser extent, the euro. On top of that, currencies of several Middle East oil producers are pegged to the dollar, adding to the importance of a relationship between the U.S. buck and the commodity.

RBC Capital Markets, BP

Europe and the U.S. outweigh China in terms of oil demand

“Buying a large stake in Aramco would allow China to secure part of its oil import requirements and increase China’s leverage in coaxing Saudi Arabia to accept yuan payments for oil,” Trinh said.

For the Middle Eastern kingdom, accepting yuan could be a chance to increase its footprint in Asia, as its China business has decreased over the past years. In 2017, China imported 14% of its oil from Saudi Arabia.

Also read: OPEC oil ministers will face this dilemma when they meet to extend production cuts

RBC Capital Markets, Bloomberg

Recently, Russia has surged to the pole position of oil exporters to China

Meanwhile, much of Asian oil imports are medium sour crude, as opposed to the lighter crude types that comprise the major benchmarks Brent LCOF8, -0.92%  and WTI CLZ7, -0.57%

Back in 1993, China actually created its own oil futures, but the contracts only traded for 18 months before being scrapped due to high volatility, Trinh said. And then there are challenges because of China’s currency, which isn’t freely floating but held in its bounds by the government.

“Moreover, a Chinese crude oil future denominated in yuan will not be convertible and would be under state influence since the government still maintains discretion over the yuan, raising concerns that pricing will favor state oil companies,” said Trinh.