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NEW YORK — China’s launch on Monday of its crude futures exchange will improve the clout of the yuan in financial markets and could threaten the international primacy of the dollar, argues a new report by Hayden Briscoe, APAC head of fixed income at UBS Asset Management.
The launch of the oil futures denominated in China’s renminbi currency, also known as the yuan, is China’s first commodity derivative open to foreign investors. This marked the culmination of a decade-long push by the Shanghai Futures Exchange (ShFE) to give the world’s largest energy consumer more power in pricing crude sold to Asia. Already on Monday, Unipec, the trading arm of Asia’s largest refiner Sinopec, has inked a deal with a western oil major to buy Middle East crude priced against the newly-launched Shanghai crude futures contract.
This helps cement the exchange’s viability and challenges the petro-dollar system, in which oil deals are executed in dollars. This would decrease demand for the greenback and boost U.S. inflation. China surpassed the United States in 2017 to become the world’s largest oil importer. Nevertheless, the existing price benchmarks — Brent and WTI crude — are both in dollars, and importers across the world must buy dollars in order to conduct oil deals. But the move to trade oil in yuan will diminish the role of the greenback in global financial markets, argues Briscoe. Pricing oil in renminbi and launching a trading hub will raise China’s prominence and integrate it further in global markets. And demand for yuan from foreign investors eager to participate in the Shanghai International Energy Exchange will boost the currency’s value and divert trading away from the dollar. Appetite for dollars would shrink, driving the price of the currency down. The renminbi’s prominence will only grow with China’s consumption: demand will increase 30.6 per cent to 753 million tons per year in 2040, according to BP. This power will let China bypass the petro-dollar system and demand that its oil purchases be priced in yuan, as seen in Monday morning’s Unipec deal. This may be even more likely in deals in which China has outsized leverage, such as their offer to buy 5 per cent of Saudi Aramco. As it stands, oil exporters store the revenue from their U.S. oil sales in Treasury bonds — a process known as “petro-dollar recycling.” As a result, the rise of the petro-yuan would also jeopardize a key source of financing for U.S. deficit spending.
Already on Monday, Unipec, the trading arm of Asia’s largest refiner Sinopec, has inked a deal with a western oil major to buy Middle East crude priced against the newly-launched Shanghai crude futures contract.
One of its strategies to deter excessive price swings is to set related crude storage costs in China at levels that are at least twice the rate elsewhere. That’s seen discouraging speculators interested in conducting so-called cash and carry trades, which seek to take advantage of differences between the spot price and futures of a commodity. This will be highly detrimental to the contract’s performance, and will actually contravene the intended purpose. Discouraging storage will actually increase volatility. It will also increase the volatility in the basis between the INE price and the prices of other oil in China.
The fact that discouraging storage will make the contract more vulnerable to corners and squeezes will further increase this basis volatility. This will undermine the utility of the contract as a hedging mechanism. Where will hedging interest for the contract come from? Unlike in say the US, there will not be a large group of producers will big long positions that they need to hedge (in part because their banks insist on it). Similarly, there is unlikely to be a large population of traders with inventory positions, as most of the Chinese crude is purchased by refiners.
The incentives of refiners to hedge crude costs are limited, because they have a natural hedge: although they are short crude, they are long products. To the extent that refiners can pass on crude costs through products prices, their incentives to hedge are limited: this is why there is a big net short futures exposure (directly and indirectly) by producers, merchants and processors in WTI and Brent: sellers of crude (producers and merchants) have an incentive to hedge by going short futures because they have no natural internal hedge, and the big refiners’ natural hedge mutes their incentive to take long positions of commensurate size.
Do not underestimate the importance of this development, because it marks the beginning of a new monetary era, which will be increasingly understood to be post-dollar. The commencement of the new yuan for oil futures contract may seem a small crack in the dollar’s edifice, but it is almost certainly the beginning of its shattering. America’s response to China’s monetary maneuvering has always been that of a nation on the back foot.
For the last year, the yuan has been rising against the dollar, following President Trump’s inauguration. Instead of responding to China’s hegemonic threat by increasing America’s role in foreign trade, President Trump has threatened all and sundry with trade restrictions and punitive tariffs. It is a policy which could not be more designed to undermine America’s global economic status, and with it the role of the dollar. In monetary terms, this leads us to a further important parallel with Germany nearly a century ago, and that is the contraction of the territory and population over which the mark was legal tender then, and the acceptance of the dollar today.
The loss of Germany’s colonies in Asia and Africa, Alsace-Lorraine to France, and large parts of Prussia to Poland, reduced the population that used the mark without a compensating reduction of the quantity of marks in circulation. Until very recently, most of the world was America’s monetary colony, and in that context, she is losing Asia, the Middle East and some countries in Africa as well. The territory that offers fealty to the dollar is definitely contracting, just as it did for the German mark after 1918, and as it did for the Austro-Hungarians, whose Austrian crown suffered a similar fate.
originally posted by: TREESNAKE1111
This is a big deal . Imo .