How serious is the challenge of the petroyuan?

Russia’s war in Ukraine and the western sanctions in retaliation only added to the momentum by opening up the space for emerging payment and trade systems.

The challenge to the dollar’s hegemony entered this new phase after President Xi Jinping’s December meeting with Saudi and Gulf Co-operation Council (GCC) leaders at a summit in the Saudi capital, Riyadh, where he made it clear that the rising Asian power wants that more and more global oil trade carried out in renminbi, not dollars – something Credit Suisse analyst Zoltan Pozsar has called the birth of the “petroyuan” in a note to clients.

“China wants to rewrite the rules of the global energy market,” wrote Pozsar in this note quoted widely in western media, as part of a larger effort to “de-dollarise”. China’s intentions in this regard had first surfaced in 2018.

The first step of this rewrite of global oil trade order, as Pozsar wrote, could be the yuan slowly edging the dollar out from China’s oil trade with the BRICS countries or Brazil, Russia, India and China. Already, Russia and China have been carrying out some trade in renminbi since 2015.

That China would like the GCC to follow is obvious from Xi’s promise to the six countries that Beijing is a guaranteed and large buyer of oil for trade settled in yuan. China is the largest importer of crude in the world. More than a quarter of China’s crude imports come from Saudi Arabia.

Besides increasing oil imports from the six GCC countries, China will also, Xi indicated, increase control over the global reserves by scaling up the engagement to cover joint exploration and production in the South China Sea for instance, and partnerships for investments in refineries, chemicals and plastics. Xi invited the GCC countries to make full use of the Shanghai Petroleum and Natural Gas Exchange for yuan-denominated trade.

The numbers do not yet suggest any sort of imminent threat to the hegemony of the dollar, the preferred and as yet unchallenged currency for global trade. The yuan accounts for around 2.7% of merchandise trade settlements, while the dollar accounts for 41%.

But the peculiar characteristics of the global energy market make the rise of the petroyuan over time a distinct possibility.

Russia, Iran and Venezuela that together account for 40% of the proven oil reserves of the Opec+ are already selling to China at steep discount, and often in renminbi. If the GCC too begins to cosy up to China, as Xi is aiming for, then that will cover another 40% of the global proven reserves.

What this means is that all the global energy market could go multipolar – although the petroyuan isn’t about to replace the petrodollar overnight.

The GCC’s exposure to Western, dollar-denominated financing will be a speed breaker. For the dollar’s real strength comes not from its use for merchandise trade but it being the currency on which global financial architecture rests. What China wants goes beyond disrupting and putting up rivals to the dollar-dominated SWIFT (Society for Worldwide Interbank Financial Telecommunication) global payments system that Russia and its supporters have been sanctioned against.

Other factors work against the renminbi. China still does not meet most of the prerequisites for making the yuan replace the dollar as the currency of global trade. These include trust of users, rule of law for disputes to be taken to credible judicial system and reserve currency liquidity. In the narrow case of oil trade, though, the dominant sellers too do not meet many of these prerequisites. In retaliation against the US-led sanctions over the Ukraine war, Russia has increased its use of the renminbi and China’s CIPS (Cross-Border Interbank Payment System), bypassing SWIFT. Plus, the Chinese have offered to make the renminbi convertible to gold on the Shanghai and Hong Kong gold exchanges, in the hope of slowly gaining trust.

The factors that could contribute to the shift away from dollars accelerating include affordability. A recent example of this is Germany’s BASF move to scale down its chief plant in Ludwigshafen and shift part of the operations to Zhanjiang, China. This is opposed to what the US is seeking: a reordering of global supply chains and trade to align global trade and business with geopolitical considerations, and which it is calling “friendshoring”.

Political reasons too favour China’s petroyuan ambitions. Xi’s historic visit came at a time when Riyadh’s relationship with Washington is on test over human rights, energy policy and support for Russia.

Saudi Arabia is the world’s second-largest oil producer and the top oil exporter. The Chinese are out to reorder one of the most important geopolitical alliances of the last seven decades that goes back to U.S. president Franklin Delano Roosevelt’s meeting with Saudi King Abdul Aziz Ibn Saud on the American cruiser USS Quincy on Valentine’s Day in 1945, after which global oil trade has been carried out mostly pegged in dollars.