China launched last Monday trading of the yuan-priced crude oil futures contracts at the Shanghai International Energy Exchange (INE), taking its first steps towards paying for imported crude oil in yuan instead of the US dollar.
As of now, oil markets have been long dominated by two financial futures instruments: U.S. West Texas Intermediate (WTI) and Europe’s Brent crude.
WTI is the main benchmark for US crude grades and a crucial hedging tool for the US oil industry, while, Brent serves as the primary value marker for Europe, Middle East and African crude. Both of them are used extensively by industry and financial traders.
In contrast, Asia, despite its position as the world’s biggest oil consumer, so far has lacked a financial instrument for crude trading. Singapore, Japan and Dubai have ever made attempts to establish one, but have not gained wide success to the end.
As the world’s most traded commodity, oil has an annual trade value of around $14 trillion, roughly equal to China’s gross domestic product last year. So shifting just part of global oil trade into the yuan will have a potentially huge effect on global oil markets.
Being the biggest buyer of oil, it’s only natural for China to push for the usage of yuan for payment settlement. Also, this will improve the yuan liquidity in the global market.
China is the world’s second-largest oil consumer and replaced the United States to be the biggest importer of crude oil last year. Its demand is a key factor for global oil prices.
Shanghai’s yuan-dominated crude futures would mark a major step in reviving usage of the currency of the world’s second-largest economy for offshore payments after several years of stop-and-go measures, which helps to give China more power over global oil prices.
If successful, it could also push forward shifting other product payments to the yuan, including metals and mining raw materials.
Even though China’s new crude futures are unlikely to displace the Brent and WTI benchmarks in the United States and Europe, they have a fair chance of successfully becoming a regional benchmark for the medium and heavy sour crude favored by refiners in Asia.
The new crude futures will also help the Chinese government in its efforts to internationalize renminbi (yuan).
China’s plan to pay for oil in yuan comes amid a more than year-long gradual strengthening of the currency, which is widely expected to post a fifth straight quarterly gain.
The yuan held its fifth ranking as a domestic and global payment currency in January this year, unchanged from a year ago, but its share among other currencies fell to 1.7 percent from 2.5 percent, according to industry tracker SWIFT.
Notably, however, the yuan has appreciated 3.4 percent against the US dollar so far this year, with solid gains in recent period.
For China’s central bank and other regulators, internationalization of the yuan is clearly one of the priorities now, and if the plan of yuan-dominated oil trading goes off smoothly, they can start thinking about replicating this model for other commodities purchases.
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