Bill O’Grady | PDF
In December, General Secretary Xi made a state visit to the Kingdom of Saudi Arabia (KSA) where he discussed the potential for trading oil in CNY. Although nothing formal was signed on this issue, Xi suggested that the KSA should trade oil and gas using the CNY for settlement. Talks between China and the KSA have been underway for some time, and there is a certain logic to making this change as China is the world’s largest oil importer and the KSA is its largest supplier. For China, being able to buy oil with its own currency would reduce its need to acquire dollars to secure oil supplies. For the KSA, accepting payment in non-dollar currencies would improve ties between the two nations.
Accepting payment for oil in currencies other than the dollar would be a major change in practice and has raised concerns about the dollar’s reserve status. This discussion has triggered sharp divisions between some of the brightest minds in finance. The potential for the emergence of a new payment system could bring notable changes to geopolitics and financial markets.
The dispersion of opinion on this issue is due, in part, to the “siloing” effect in academia and research. Few foreign exchange or international finance analysts have a deep understanding of the energy markets, while most oil and gas analysts are not experts in foreign exchange or international finance. This situation is unfortunate, because the experts on international finance tend to underestimate the critical nature of oil, while oil analysts miss the complexity of foreign exchange. We will attempt to, at least partially, bridge that gap in this report.
In this (rather lengthy) report, we will begin with a short history of the geopolitics of oil and its intersections with finance. This section will include a discussion of the sanction regimes implemented against Iran and Russia, which have raised concerns among other nations. Included is an examination of the basics of reserve currency economics. The next section will examine the emerging structure of the petroyuan system. Following that will be a framing of the debate on the threat of the emerging petroyuan: Is it a replacement of the dollar system, or not? We will close with the potential market ramifications of a parallel reserve currency regime.