Will China Forming Oil Buying Cartel End the Petrodollar?

Authored by Tom Luongo via Gold, Goats, ‘n Guns blog:

China is building a buyer’s group (or cartel) comprised of its major state oil companies. I’m frankly surprised that this wasn’t already the case, since everything else is tightly controlled in China.

A report from Bloomberg (via Investing.com) states that:

Senior executives from China Petroleum (NYSE:SNP) & Chemical Corp., PetroChina Co., Cnooc Ltd. and Sinochem Group Co. are in advanced talks to iron out details of the plan, said people familiar with the initiative, who asked not to be identified as discussions are private and ongoing. The proposal has won the support of the Chinese central government and relevant industry watchdogs, the people said.

Since China is now the world’s largest importer of oil it only makes sense they would flip the switch and act as price makers rather than be price takers.

This makes perfect sense, economically, in the current environment as troubled oil exporters like Saudi Arabia continue to try and exert influence over the oil market.

The Saudis refuse to admit to themselves that their era of dominance over oil prices is, itself, over. As I noted in my blog from last week their attempt to gain market share through price slashing did nothing more than slash their own revenue to the bone, while making no new friends.

They shipped out 50% more oil and revenues plunged by 65%. They practically gave the stuff away in April. They had to. With the Riyal tied to the dollar they had to undercut Russian oil which trades in freely-floated rubles.

Because while China is certainly happy to pay less for oil, the knock-on effects of undermining its capital markets were and are far greater than the savings per barrel.

And that made them no new friends in the Poliburo.

That Crown Prince Mohammed bin Salman (MBS) acted to rashly in March I’m sure did not sit well with Chinese leadership. They clearly have no use for such an unreliable partner who refuses to take anything other than the U.S. dollar for its product.

To remind everyone, MBS threw his tantrum which locked up global markets after Russia’s refusal to agree to further OPEC+ production cuts in March. That precipitated the massive drop in oil prices which started the financial crisis.

So, it’s pretty obvious to me now that China seeks to further marginalize Saudi Arabia and the U.S. in the oil space.

The proof? Back to the Bloomberg article:

For a start, the group is set to collectively issue bids for certain Russian and African grades in the spot market, they said. While it’s unclear how the cooperation will evolve, the group represents refiners that import more than 5 million barrels of oil a day. That’s nearly a fifth of OPEC’s total output, which would make it the world’s largest crude buyer in theory.

Because here’s the rub, as always, China is looking for ways to deepen international use and liquidity of the yuan. Saudi Arabia and the U.S. want to continue use of the dollar as the main settlement currency for oil trading, the so-called petrodollar.

It is the petrodollar that provides the most inertia the world fights against to allow the rise of other currencies as settlement. Dollars are cheap to use, freely accepted and, for now, still a good store of (at least) medium-term value.

The petrodollar was created by the relationship between the U.S. as the biggest importer and Saudi Arabia the biggest exporter. As long as that relationship held the petrodollar flowed into foreign central banks, deepening everyone’s trust in it.

Now China is saying things have changed. Europe and China are willing to pay a little more for Russian Urals grade (per my article from Friday) after MBS’s tantrum.

Moreover, China wants its oil futures contract in Shanghai more dominant in the global market. That contract is a key piece to deepening Yuan liquidity.

Shifting the oil trade where it can trade in real time versus would be a boon to the market. Most of the Arab states set their tender prices at the beginning of the month and they don’t change.

Back to Bloomberg:

Importers … have struggled this year to manage the amount of crude received each month amid fluctuating domestic demand, refining margins and swelling stockpiles.

Volumes can only be adjusted slightly from earlier-agreed liftings, and final decisions lie with the seller. Saudi Aramco, Iraq’s SOMO and Abu Dhabi’s Adnoc all sell their crude at official prices announced early each month.

Indian processors and ports went so far as to declare force majeure in attempts to back out of crude liftings after the world’s biggest lockdown slashed demand.

What this cartel will do is create the opposite dynamic than has existed previously. Buyers will dictate terms to the sellers, which is the way the market is supposed to work.

And it’s goal, I think, is to break the monthly price tender system and put more volume up for open bid in Shanghai.

Cartels are inherently unstable but, at times, under extreme circumstances, they can be very effective at creating change to a sclerotic system. I think this is exactly what China is looking to do here.

Watch to see if this cartel comes together. If it does then in order to save itself, Saudi Arabia will have to come to Chinese importers head scarf in hand looking for business.

At the same time, because they accept other currencies for their oil, Russia stands to take more market share. They can always grind out the arbitrage in currency terms between the Saudi monthly tender price and their own COGS.

Lastly, don’t think for a second that China isn’t willing to pay a little more here or there to deny MBS and President Trump a few billion in much-needed export revenue and hand it to their partners in Russia.

Especially when you factor in the real arbitrage that neither country can offer better terms on, that of the real yield on a Russian government bond and a U.S. bond.

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