Two topics we’ve deemed critically important to a thorough understanding of both global finance and the shifting geopolitical landscape are the death of the petrodollar and the idea of yuan hegemony.
Last November, in “How The Petrodollar Quietly Died And No One Noticed,” we said the following about the slow motion demise of the system that has served to perpetuate decades of dollar dominance:
Two years ago, in hushed tones at first, then ever louder, the financial world began discussing that which shall never be discussed in polite company - the end of the system that according to many has framed and facilitated the US Dollar's reserve currency status: the Petrodollar, or the world in which oil export countries would recycle the dollars they received in exchange for their oil exports, by purchasing more USD-denominated assets, boosting the financial strength of the reserve currency, leading to even higher asset prices and even more USD-denominated purchases, and so forth, in a virtuous (especially if one held US-denominated assets and printed US currency) loop.The main thrust for this shift away from the USD, if primarily in the non-mainstream media, was that with Russia and China, as well as the rest of the BRIC nations, increasingly seeking to distance themselves from the US-led, "developed world" status quo spearheaded by the IMF, global trade would increasingly take place through bilateral arrangements which bypass the (Petro)dollar entirely. And sure enough, this has certainly been taking place, as first Russia and China, together with Iran, and ever more developing nations, have transacted among each other, bypassing the USD entirely, instead engaging in bilateral trade arrangements.
Falling crude prices served to accelerate the petrodollar’s demise and in 2014, OPEC nations drained liquidity from financial markets for the first time in nearly two decades:
By Goldman’s estimates, a new oil price “equilibrium” (i.e. a sustained downturn) could result in a net petrodollar drain of $24 billion per month on the way to nearly $900 billion in total by 2018. The implications, BofAML notes, are far reaching: "...the end of the Petrodollar recycling chain is said to impact everything from Russian geopolitics, to global capital market liquidity, to safe-haven demand for Treasurys, to social tensions in developing nations, to the Fed's exit strategy.”
Shifting to the idea of yuan hegemony, China is aggressively pushing its Silk Road Fund and Asian Infrastructure Investment Bank.
The $40 billion Silk Road Fund is backed by China’s FX reserves, the Export-Import Bank of China, and China Development Bank and seeks to increase ROIC for Chinese SOEs by investing in infrastructure projects across the developing world, while the $50 billion AIIB is funded by 57 founding member countries (the US and Japan have not joined) and will serve to upend traditionally dominant multilateral institutions which have failed to respond to the rising influence and economic clout of their EM membership. China will push for the yuan to play a prominent role in the settlement of AIIB transactions and may look to establish special reserves in both the AIIB and Silk Road fund to issue yuan-denominated loans.
Back in early November, SWIFT data showed that 15 new countries had joined a list of nations settling more than 10% of their trade deals with China in yuan. "This is a good sign for [yuan] adoption rates and internationalisation. In particular, Canada's [yuan] usage for payments, which has increased greatly over this period, is very interesting since we have not seen strong adoption of the [yuan] from North America to date,” Astrid Thorsen, Swift's head of business intelligence said.
Earlier that month, China and Russia indicated that going forward, more trade between the two countries would be settled in yuan. From Reuters, last November:
Russia and China intend to increase the amount of trade settled in the yuan, President Vladimir Putin said in remarks that would be welcomed by Chinese authorities who want the currency to be used more widely around the world.Spurred on by their often testy relations with the United States, Russia and China have long advocated reducing the role of the dollar in international trade.Curtailing the dollar's influence fits well with China's ambitions to increase the influence of the yuan and eventually turn it into a global reserve currency. With 32 percent of its $4 trillion foreign exchange reserves invested in U.S. government debt, China wants to curb investment risks in dollar.The quest to limit the dollar’s dominance became more urgent for Moscow this year when U.S. and European governments imposed sanctions on Russia over its support for separatist rebels in Ukraine.
"As part of our cooperation with this country (China), we intend to use national currencies in mutual transactions.The initial deals for rouble and yuan are taking place. I want to note that we are ready to expand these opportunities in (our) energy resources trade," Putin said at the time, suggesting that going forward, Russia may look to settle sales of oil in yuan.
Sure enough, Gazprom has confirmed that since the beginning of the year, all oil sales to China have been settled in renminbi. From FT:
Russia’s third-largest oil producer, is now settling all of its crude sales to China in renminbi, in the most clear sign yet that western sanctions have driven an increase in the use of the Chinese currency by Russian companies.Russian executives have talked up the possibility of a shift from the US dollar to renminbi as the Kremlin launched a “pivot to Asia” foreign policy partly in response to the western sanctions against Moscow over its intervention in Ukraine, but until now there has been little clarity over how much trade is being settled in the Chinese currency.Gazprom Neft, the oil arm of state gas giant Gazprom, said on Friday that since the start of 2015 it had been selling in renminbi all of its oil for export down the East Siberia Pacific Ocean pipeline to China.Russian companies’ crude exports were largely settled in dollars until the summer of last year, when the US and Europe imposed sanctions on the Russian energy sector over the Ukraine crisis...Gazprom Neft responded more rapidly than most, with Alexander Dyukov, chief executive, announcing in April last year that the company had secured agreement from 95 per cent of its customers to settle transactions in euros rather than dollars, should the need to do so arise.Mr Dyukov later said the company had started selling oil for export in roubles and renminbi, but he did not specify whether the sales were significant in scale.According to Gazprom Neft’s first-quarter results issued last month, the East Siberian Pacific Ocean pipeline accounted for 37.2 per cent of the company’s crude oil exports of 1.6m tonnes in the three months to March 31.
With that, the "PetroYuan" has officially been born and while FT notes that "other Russian energy groups have been more reluctant to drop the dollar for settlement of oil sales," the fact that Russian producers are now openly considering a shift at the same time that officials in the US and Europe are openly discussing stepped up economic sanctions suggests renminbi settlements may become more commonplace going forward.
To understand why and to what extent this is significant in the current environment, consider the following from WSJ:
Officials of the Organization of the Petroleum Exporting Countries, which declined to cut oil production last year, reasoned that maintaining high production levels would protect market share in crucial importing nations.;But Chinese customs data released Friday show that China’s crude imports from some big OPEC nations have plummeted, while imports from Russia surged 36% in 2014. Meanwhile, imports from Saudi Arabia fell 8% and those from Venezuela dropped 11%.
To summarize: Western economic sanctions on Russia have pushed domestic oil producers to settle crude exports to China in yuan just as Russian oil is rising as a percentage of total Chinese crude imports. Meanwhile, the collapse in crude prices led to the first net outflow of petrodollars from financial markets in 18 years, and if Goldman's projections prove correct, the net supply of petrodollars could fall by nearly $900 billion over the next three years. All of this comes as China is making a concerted push to settle loans from its newly-created infrastructure funds in renminbi.
Putting it all together, the PetroYuan represents the intersection of a dying petrodollar and an ascendant renminbi.
