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Several weeks ago in an article, “China’s Gold Scheme to Back Energy,” I explained how China was posturing to provide oil futures priced in yuan. This would allow oil exporting nations to accept yuan as payment and would allow them to convert the yuan into gold through Shanghai. This process would create a demand for oil, gold, and yuan. Clearly, the demand for gold and yuan would increase, versus a decrease in demand for dollars. This infrastructure build-out has been happening for the last 20 years but has increased even faster the last 10 after the financial crisis. China first attempted this contract in 1993 and has been delaying it ever since. Back in October 2017, the information was suggesting a contract launch date at the end of December. Geopolitical tensions in and outside of China delayed this launch date to the end of January. Exchange schematics and tensions did not allow the contract launch date to happen at that time, and the date has now been delayed to March 26th.

Shanghai futures contracts will be 1,000 barrels per lot. This seems to be a necessary move, as China became the number one importer of oil in the world in 2017. China imported 8.43 million barrels per day last year, according to Bloomberg, as part of their Strategic Petroleum Reserve Initiative.

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This initiative is a Chinese state initiative where private companies have to adhere to quotas led by the government, which have expanded over the last 18 months. They’ve been increasing imports, likely due to the anticipation of this oil contract. Logically, it makes sense that more oil is being accumulated because a futures contract means you need the oil to swap back and forth. Liquidity will be key in this market, especially when it’s brand new. Futures can be traded or hedged via the yuan, which wasn’t possible before. Several oil analysts in China see this as a game-changer because foreign producers and consumers can now hedge on a domestic Chinese commodities exchange. Many investors and commodity arbitrageurs have been trying to access this market for years, and it will now be possible. Chen Tong, an oil analyst with Tianjin-based First Futures Company, told Bloomberg, “First, the trading volumes need to get active, then domestic refiners need to end up using it as a benchmark for trading, and eventually, it could reach its aim of becoming a pricing benchmark for Asia. For yuan internationalization, of course, it fits the mission, with more and more oil producing countries moving away from dollar-linked oil contracts.” We know that reserve currencies have come and go throughout history. Wars, famine, and natural disasters move their way through a normal cycle just like empires. They take time to develop and play out at a very slow pace. Watching the dollar slowly dwindle away has been like watching paint dry, but the next few years will be much faster. Watching the yuan develop will take time as well. Over the next few years, China will continue its goal of yuan internationalization, but in doing so, will face major headwinds from the old order and their own economic limitation. Launching this contract as imports increase, Venezuela pushing an oil-backed cryptocurrency, and Iran trading outside of dollars will make the dollar more like Charmin.

Cheers,

Colin

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