Blog

After 25 years of waiting, setbacks and aborted attempts, China made history on March 26, 2018, when its oil futures were formally listed on the Shanghai International Energy Exchange for the first time. Note that this is actually a long time coming – the exchange itself began to advocate for oil futures trading as far back as 2001 and China actually made its first attempt at a crude futures contract all the way back in 1993. But years of preparation have finally paid off and the international community is absolutely paying attention.

What, if anything, does this mean for the future of the international markets and what affect will this have on the strength of the petrodollar around the globe? The answer to all of those questions and more requires you to keep a few very important things in mind.

What is the Petrodollar?

Before you can fully understand exactly what China’s challenge to the petro-dollar may mean, you must first understand more about this very particular unit of currency in the first place.

The term “petrodollar” is used to describe the money that a country or particular entity makes from the sale of oil. It actually first rose to prominence during the 1970s when the oil crisis of the time saw prices balloon to record levels around the world. Petrodollars were, in part, designed to help increase the stability of oil prices and were, as a result, denominated using United States dollars.

Because of that last point, the actual value and purchasing power of petrodollars are heavily dependent on both the core rate of inflation in the United States and the current value of the U.S. dollar. It is important to note that, with few exceptions, petrodollars are often the primary source of revenue for Middle Eastern governments that deal heavily in the exporting of oil around the world.

China and the Petrodollar: What You Need to Know

Many agree that this move is representative of the country’s position as a leader in global oil futures trading – China even surpassed the United States as the world’s largest oil buyer last year. But the part of this that really has people talking is the fact that China oil futures are denominated not in the petrodollar, but in renminbi, the local currency. This has essentially led to the creation of a new term called the petro-yuan.

China oil futures are also notable for being the first commodity derivative that was actually open to foreign investors. People are already speculating that this move has the potential to decrease the demand for the American dollar worldwide, which would ultimately boost U.S. inflation in ways that are difficult to predict moving forward. Some have even called this the “single biggest change in capital markets, maybe of all time.“

But at the same time, many industry analysts agree that while the long-term implications of this move are significant, the short-term results have less of an impact. This is a first step towards China becoming a more active participant in setting the price of oil around the world. For the petro-yuan to become a true global benchmark in those regards, it will likely take many years to even begin to approach that point.

Shanghai futures will not be truly “global” for at least a decade and until that point, the affect on crude oil prices around the world will be largely theoretical. Still, this is something that people around the world will want to keep an eye on moving forward.