Petro-Yuan Not Quite Yet: Chinese Oil Futures a Risky Endeavor

The death of the petrodollar has been delayed.

By Irina Slav, Oilprice.com:

When the long-awaited yuan-denominated oil futures launched earlier this year, opinions were split: one camp argued with passion that the days of the petrodollar were numbered, its demise a certainty. The other camp argued with just as much passion the yuan has yet to catch up with the dollar as an international currency, and the Chinese futures had basically as much of a chance as a snowflake in hell.

Six months later, opinions remain split, but now the two camps have some facts and figures in their arsenal. For example, a figure for the pro-petroyuan camp was the record surge in trading volume in June, to 137.5 million tons of crude for delivery in September. This translates into 137,503 lots, compared to a combined 2.6 million lots for Brent and WTI together, though, so the yuan contract still has a way to go to catch up.

The anti-petroyuan camp, however, seems to have a bit more going for it after six months of trade. Bloomberg cites traders as saying that the exchange rate of the yuan coupled with storage costs make the Chinese oil contract still a high-risk endeavor.

The yuan has been falling in recent months on the back of slowing economic growth and the tariff spat with the United States. There is a lot of space for surprises, however, and unpredictability is not something low-risk traders like, so exchange rates are one thing that could put them off the yuan contract.

Storage costs in China are another problem. They are much higher than elsewhere: US$0.95 per barrel per month in the Shanghai International Energy Exchange compared with US$0.05 per barrel per month at the Louisiana Offshore Oil Port, Bloomberg reports. The reason for the higher cost is limited storage capacity availability and the requirement that the cargo be stored at a specific storage facility rather than at any available.

So, in light of these unpleasant facts, what does the yuan-denominated futures contract have going for them? Well, apparently, they could make sellers richer than if they choose to trade Middle East grades. The yuan contract last week traded at a considerable premium to all other oil futures, with the premium to the Middle East benchmark at US$3.35 per barrel. That makes a profit of US$6.7 million for a cargo, according to Bloomberg calculations—certainly not a small sum. But is it worth all the risks?

Perhaps it is and perhaps it isn’t, but it looks like it is still too early to say. The seriousness of the risks, after all, is relative. This was evidenced in the record-high trading interest in yuan futures in early June that some observers, quoted by S&P Global Platts, attributed to the heightened price volatility in the Brent and WTI benchmarks. On the other hand, storage costs are a fixed problem that is not about to go away. It’s a risk that traders have probably already learned to factor into their calculations. Exchange rates are another cesspool of volatility, but volatility is a double-edged sword. Economic data from China may still surprise positively as it has before, despite the tariffs.

Ultimately, however, the question of whether the petrodollar will be replaced by the petroyuan is moot. The reason for this is simple: the dollar is the international reserve currency because most oil is traded in dollars, says international relations professor and China expert Douglas Bulloch. It is the international reserve currency because of the size and nature of the U.S. economy. Therefore, the only way for China to succeed in having its currency stand a fighting chance against the greenback is to continue opening up its economy. Oil trading is only part of that. By Irina Slav, Oilprice.com

This time was supposed to be different. Read…  Shale Profits Remain Elusive

Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:

Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.




  19 comments for “Petro-Yuan Not Quite Yet: Chinese Oil Futures a Risky Endeavor

  1. andy says:

    What is petrodollar? Is that a thing?
    If so, how can we stop anti-petroyuan camp?

  2. ZeroBrain says:

    If the Chinese are serious about replacing the dollar, they can build more storage facilities just as easily as they can build ghost cities, can they not? Anyways, 5% of contracts is nothing to sniff at for a recently introduced exchange.

    • MC01 says:

      China has been building up storage capacity since 2004, when official figures started to be made available to foreigners and the Five Years Plan running 2017-2022 calls for an absolutely unbelievable increase in crude storage capacity: from the present 3.7 million m³ to 11.7 million m³!
      The official reason is a massive increase in the strategic reserves China projects storing in the future, but it’s very likely China’s chaotic energy policies and their now infamous financial shenanigans have a big hand in this.

      When one looks up any report on the Chinese oil industry he’s bound to find the term “teapot refinery” used. What’s a teapot refinery?
      It’s a small refinery, up to 100,000bpd (barrels per day), privately-owned refinery which is widely held to be “inefficient” when compared to the mega petrochemical complexes operated by State-owned companies such as Petrochina. They are mostly located in the Shandong province, but in the last couple of years they have cropped up in many other places.
      Up to 2016 these teapot refineries could only use either domestically-produced crude or intermediates purchased from a State-owned refinery, but in that year the law was changed and teapot refineries are now allowed to directly buy crude from abroad. The owners have to apply for import quotas but these are generally just a formality as they are invariably granted by the government.
      So far, so good.
      The problem is these teapot refineries have been used as fronts for all sorts of financial shenanigans.
      Already in July 2016 it was found many teapot refinery owners were lying (or at least not telling the whole truth) about current capacity to be allowed to import more crude. This extra crude was then sold in what seems to be yet another “shadow” or “parallel” market. Like in banking it’s obvious the government knows what is happening and is fine with it, as nothing has been done to stop these movements.

      Rather more worrisome is the fact these foreign oil transactions appear to be yet another vehicle of capital flight: SAFE (State Administration for Foreign Exchange) has issued several notes vowing to “verify the authenticity of oil trade” as “most trades are fake”.
      As the yuan continues its slow slide against the US dollar the practice of over-invoicing is becoming more and more common. How effective are measures taken by SAFE we can only guess.

      I think we’ll hear about many more Chinese shenanigans in the oil market over the next few years.

      • Ambrose Bierce says:

        There are projections that global oil demand will increase solely on the need for BRIC countries like China and Brazil to build a national reserve, as a contingency. Above ground storage adds a premium to the price, while the US salt dome is relatively cheap. The other advantage of storage is that it allows the nation which is buying oil on the international market to manipulate their storage figures. The US did this after Katrina, when government and enterprise storage were comingled to present a false impression of inventory and allow enterprise buyers to negotiate better prices with Saudi tankers. Traders finally paid no attention to inventory, and it seems that only crack spreads were worth watching. Now the US is an exporter of energy, but the purpose of keeping a strategic reserve is still done for the benefit of a government/enterprise system. Governments which weaken their currency for the export advantage, can manipulate reserves when they are importing oil.

        • MC01 says:

          Every single prediction about the energy industry I’ve read since 1986 has so far proven to be if not spectacularly wrong at least very inaccurate.
          For example nobody back in 2009 foresaw how much crude refining capacity France, Italy and Germany would lose between them despite the new Total refinery opening in Normandy.

          China is building storage capacity everywhere these days. Much room was given to the fact the new oil reserves will need 23,000km of newly laid pipelines, which will no doubt be a major boon for the local steel mills drowning in excess capacity, and I suspect that’s the elephant in the room.
          The Japanese government has built enormous crude storage facilities in Kagoshima and Okinawa, officially to increase strategic reserves, but really as a make-work project for their keiretsu. They have so much idle storage capacity they are leasing it at no cost to Saudi Aramco and the Abu Dhabi National Oil Corporation (ADNO) as trans-shipment points and storage facilities. Why the “no cost” part? Because the agreements with ADNO and Aramco allow the Japanese government to count half the crude stored by the Arab oil companies as a strategic reserve “or “national crude reserve”, as Japan prefers calling it. The ADNO deal also offers some “special drawing rights” apparently.

          China adding 8 million m³ reserves in just five years dwarf anything Japan has ever done and is likely to add yet another layer of overcapacity to an economy that’s not just drowning in it, but which has become overdependent on it.
          What will China do with all that capacity, assuming it can all be used (underground facilities have a nasty tendency to leak crude unless perfectly insulated), remains to be seen but I bet the presidents, CEO’s and chairmen of a legion of companies ranging from steel mills to metering systems are rubbing their hands as we speak.

  3. Jarhead John says:

    “The petro-dollar does not exist and has not since the 1970’s and therefore the petro-yuan has no future.” (Forbes, Why the Petro-Dollar is a Myth and the Petro-Yuan is a Fantasy—-April 28, 2018).
    I believe only about 10 percent of global trade is oil, necessitating dollars for the remaining 90 percent…and even in the oil trade, banks are requiring yuan be converted to dollars on the foreign exchange market.
    The American debt market is the Only option where mega money globally is parked…Therefore, it seems to me that Only the dollar will continue as the global reserve currency. The Renminbi has not been permitted to float, as is needed to have a reserve currency. China for all intent and purpose still has a command and control economy. Their shadow banking infrastructure is massive and capital has been fleeing the country (e.g. Canadian Real Estate) effecting the stability of the yuan.
    The Chinese may wish to eliminate dollar hegemony, but so far, the petro-yuan seems to be nothing but a dog and pony show.

    • Robert says:

      ” The Renminbi has not been permitted to float, as is needed to have a reserve currency.” I’d think if you wanted to be a reserve currency you shouldn’t expect to get away with perpetually running massive budget deficits(i.e., printing money)- as the U.S., among others does. Central bankers are a very clubby bunch, but how the hell does CB A really know how many yuan, dollars, lira or rubles CB B is really cranking out in the basement? (which explains why the gold standard was the norm for a long time.) For all of the Yuan’s shady nature, the Chinese have managed to accumulate vast amounts of resources and high end property around the world, so they must be doing something right with their yuan.

      • Jarhead John says:

        Pertaining to budget deficits with a reserve currency, I think what you are talking about is known as Triffin’s Paradox…

    • Frank says:

      Frederick, Your anti- semitic comment is more appropriate to that cesspool of racism Zero Hedge. Over on that blog you’ll find many commentators that will obviously agree with you that the root of all evil is always the Jews. The reason most of us like to read this blog is the more enlightened nature of Wolf’s commentary and reporting.

      • ZeroBrain says:

        Oh my, where to begin. Your comment looks like flamebait, but I’ll bite. Fred made no indication that his criticism of Rothschild was connected to Rothschild being Jewish. What, is it no longer in vogue to criticize bankers? Would it have been okay if it were JP Morgan instead? Your ad hominem strawman argument is better suited to ZeroHedge.

    • Sinbad says:

      About floating value currencies, the US dollar was a fixed value until Nixon defaulted on the dollars for gold agreement of Bretton Woods.
      A fixed value currency gives confidence and surety to the traders who use the currency. A reserve currency is a relic from a bygone era, and a millstone on the country that has it.
      A nations currency value is like the share price of a company. I think the US is currently a bit like Netflix, great share price for a company that loses money.

  4. Augusto says:

    Investors are nuts to think that any creation of China isn’t for the benefit of China. And if you think you can find some Wall Street shill to predict and profit off of this Communist-Mercantilist monstrosity good luck (for you, really). Given a choice, the great citizens of the People’s Republic would get themselves, their families and their money offshore the Heavenly Kingdom in a heart beat. Now, if we could trade their energetic entrpreneurial class for our Finance Industry parasites then I am in on that deal. However and not surprisingly, I’ll stay as far away as possible from any transaction that is mutually beneficial for Wall Street and the Communist Party. Dear God, what some people will do for a buck.

    • Rates says:

      Investors are not nuts. Your post itself contains all sorts of contradictions. “Investors are nuts to think that any creation of China isn’t for the benefit of China. “. Investors understand that any creation if China is only for the benefit of the 1% of China’s society. Same with any country really so investors are certainly NOT nuts.

      “Given a choice, the great citizens of the People’s Republic would get themselves, their families and their money offshore the Heavenly Kingdom in a heart beat.” I used to think like that, but having met a number of Chinese citizens traveling in the US, I have begun to disagree. Most of the people I met came here to see the natural wonders in the US, and most of them weren’t impressed. After seeing photographs of some scenic regions in China, I am inclined to agree with them. Do Chinese people worship money? Absolutely, but at the same time, you gotta do something with them you know? The problem with China is too many people which is why many want to leave.

      • Augusto says:

        Sorry don’t see the contradiction(s). I’ve been to China and know and worked with lots of ex-Chinese citizens here (in Canada). So let me assure you they want out, badly, especially if they are educated. I remember asking one woman why she left China, and her response “China is a Communist country. You don’t really own anything, not even your own life”. I don’t think its a worship of money but hope for a better future (and fear of the future in China) that makes people want to leave. After all, they know the Communists much better than we do. Unfortunately, our financial wizards will sell them the rope to hang us all with if they get an extra quarter point out of i.

        • Rates says:

          And yet you see things like these: https://qz.com/1342525/chinese-students-increasingly-return-home-after-studying-abroad/

          Your post reflects the point of view of someone who’s spent very little time inside the country. People like Zak Dychtwald (an American who speaks very fluent Chinese, spent a lot of time in the country, and wrote a book about his experiences) and many others don’t feel like that. People you meet in Canada are by definition the 1% who probably had to flee abroad with ill gotten gains and/or extremely rich.

          Is China the greatest country in the world to live in? Most probably not. But saying that any country can be your home is also delusional even if you are educated. Why? Because the reality is you’ll most likely remain a second rate citizen in your new country. For a couple of generations at least.

  5. Mean Chicken says:

    “The death of the petrodollar has been delayed.”

    Imagine that! Ever notice what the 1% needs, they get?

  6. Rates says:

    The Chinese has been working too hard. All anyone needs to do for petrodollar to disappear is to just wait till this country self destructs. Once the next civil war rolls around, the dollar will collapse on its own. Every monkey knows what’s around the corner after a country goes through a huge income discrepancy. America is no different.

    • Keith says:

      Civil war between whom, exactly? No differences are so great as to cause ‘war’ or shooting. Now maybe if the food supply chain is disrupted for a week or so, but that wouldn’t be civil war.

  7. Sinbad says:

    The problem is the lack of growth in petrodollars.
    Historically the flows of US dollars have usually increased year over year. If the flow reduces even a small amount, it reduces growth in the cash flow.

Comments are closed.