On Monday March 26th, China will start trading oil futures denominated in Renminbi. While this event wont be a game changer for oil traders overnight, and the global markets may even yawn, we would argue that there are major implications from this event, one which includes the days of the US Dollar being the sole player in commodities settlement and possibly global settlement starting to dwindle.
Here is why this event is important:
This is all about supporting China’s desire to further the Renminbi as a global reserve currency, especially as it pertains to trade settlement. This event adds to what has already been a busy 2.5 years for China asserting itself on this global legitimacy stage: HK- Shanghai Connect, Renminbi status within IMF SDRs, and even the MSCI growing China’s local A-Share share in the MSCI indices.
This also has significant geo-political implications as it relates to China buying oil from Iran, Russia, and other players who at times have found themselves or still do, outside the OPEC/US oil club. China as the largest net buyer of oil and products has proven to be a very self-interested player in securing their own energy needs, especially in Africa, and growing not just in the middle east, but also Latin America. China’s role in e global oil market has become a major impediment to the US’ attempts to isolate Russia, Iran, and China itself.
Ultimately for oil producers that include not just china, this event will continue to desire by many to see the US Dollar be less influential in setting the implied end prices of oil. A quick look to the oil price devastation of summer 2014 into Feb/March ’16 shows how the Dollar was a wrecking ball for global commodities but oil specifically and became the tail that wagged the dog in terms of a self-fulfilling oil crisis that then in turn influenced the way global central banks carried out monetary policy. I would argue the move in oil prices was significantly exacerbated by a Dollar move which was driven by an upshift in hawkishness by the Fed preparing markets for the first hike in a decade. This move then created a global deflationary spiral that forced the ECB to more extraordinary monetary easing and QE in Jan 2016 than would have otherwise been warranted. The world is dealing with that today.
For oil traders this event is significant because they foreigners can now trade for the first time in the Shanghai Free Trade Zone, and will being to create a 24-hour mkt for trading oil especially where some of the largest buyers of oil are located. Liquidity will be an issue and it will take time for these markets to be efficient. China remains one of the core players in helping to balance out the global supply demand dynamics. China saw demand in oil rise +8% y/y and is at is second highest growth rate in the last 5yrs, meanwhile production is off about 1.9% yoy.
China continues to push for a bigger role in the global reserve currency matrix and Monday’s event will add to their claim for more relevance.