Can China, Russia, and Iran Challenge the Dollar in Oil Markets?

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Can China, Russia, and Iran Challenge the Dollar in Oil Markets?

Anwar Altaqi – Esam Aziz

Two quick, and related, questions: Can an alliance among China, Russia, and Iran remove the U.S. dollar from the throne of global oil markets? And, what happened to the Shanghai yuan-based commodity market, which initially received extensive media coverage, but seems to have fallen into silence since?

Starting with the easier one — the second question — we believe the fanfare surrounding the birth of the yuan-based future contracts has blinded everyone from seeing that this market is mainly a local market, even if it open, theoretically, to global players. The project of building this market, regardless of intentions and noise, was doomed from day one to be local, at least for an extended period of time. Markets have their own logic.

Can China, Russia, and Iran Challenge the Dollar in Oil Markets?

It was natural that local traders would go to Shanghai. But why should a global trader go there, when he can go to any other tested market in the world? One thing may convince a global trader to go to the yuan market: If he has business in China, or if the commodity he trades is coming from, or going to, China. That is to say, if the transaction has a genuine local dimension. China cannot artificially give Shanghai a global dimension, unless it has the tools to do so. And in such cases, the main tool is the currency used to tie the knot in trading deals and global access to the market, including the ease of transferring funds in and out. Investors would ask themselves: Is it worth the trouble to go to an untested market, change my money to yuans and pay the fees, deal with players whom I do not know, risk margins I am not familiar with, change my profits back from yuan to dollars, and transfer the funds to my bank account in New York or London — while I could get all of this done with a telephone call to my broker on the neighboring street?

A newborn futures’ market is always a high risk market. The rules are neither tested nor established. This is why investors believe that Shanghai is ultra-speculative. Only recently, the yuan-based future contracts started to see some wind blown under their wings. The reason is the expectation that China and Iran will start dealing their oil trade in Shanghai, and in yuan, once the U.S.sanctions go into effect in November.

China created the Shanghai yuan-based market and meant to make it global. But the newly-born market was destined to reflect the facts of reality, not the intentions, plans, and legislations of its creator.

The locus of the issue is financial dominance in the global market. And the dollar is the king there. However, it was unimaginable, just one decade ago, to talk about a Chinese, or any other (besides Western) financial market. This puts us in the face of the second question: If we add all the scattered relevant developments, like sanctions on Russia, the U.S. trade war with China, the Shanghai market, and the conflict with Iran, do we see the dawn of a new global shift in trade (hence, in the currency and financial worlds)?

Normally, big shifts start from what seems to be casual and incidental events. The difference between one moment and another is that either those small events happen in a favorable environment or in an unfavorable environment. Therefore, the question is: Will the current clashes between the United States, on one hand, and China, Russia, and Iran, on the other, trigger faster progress towards toppling the dollar from the throne of the global financial system?

If this happens, it would be the most radical shift in the world order since World War I, and in the oil world since the U.S.-OPEC deal of the 1970s. It would profoundly change the world map.

But again, is too early for the yuan, or any other currency, to challenge the U.S. dollar. The yuan simply does not represent any credible challenge to the dollar, yet. The global trade system is Western in basic terms. And the West is unified to defend its dominance. The East does not at present representa weight that can overturn this dominance.

In addition to the shortcomings of Shanghai, Russia is finding it more difficult to avoid the tight grip of the U.S. currency.  Russian oil producer Surgutneftegas — whose chief executive Vladimir Bogdanov is already on a U.S. blacklist in a personal capacity — is pushing buyers, in vain, to agree to pay for oil in euros instead of dollars if the need arises, apparently as insurance against possibly tougher U.S. sanctions. Russian oil companies think day and night about one nightmare: What if the following day they receive a notification that they are included on the U.S. Treasury Department’s list of sanctioned Russian firms? Russia has been subject to Western sanctions since its 2014 annexation of Ukraine’s Crimea region, but Washington has threatened to impose extra sanctions, citing what it has called Moscow’s “malign” activities abroad.

However, there are some detectable trends that can eventually threaten the dollar. We saw some life in Shanghai future markets following the U.S. sanctions on Iran. And we see that Russian oil firms are increasingly resorting to borrowing from state banks to develop their own technology, in response to restricted access to Western finance and technology.

Most Russian oil majors, including Rosneft and Lukoil, also sell most of their output via long-term contracts, giving them more time to work out alternative forms of payment when the contracts expire. But most of, say, Surgutneftegas’s exports — around 2 million tons per month — are sold through monthly tenders on the spot market, the largest volumes by far among its Russian peers. The company would only have around 30 days to find alternative payment methods.

Yet, Surgutneftegas is only trying to change from dollars to euros. Clearly, it did not even consider Shanghai. What will it do with a ton of yuans other than buy Chinese products?

This question does not apply in the case of Iran, though. Iran can use Chinese products to fill some gaps in its import lists. However, the moment Iran is allowed into the global market again, it will turn its back in a minute on the yuan.

Will an alliance amongChina, Russia, and Iran topple the dollar from its financial throne then?A categorical “no” is the only answer, at least for now. However, no one can deny the small developments taking place and their cumulative effects. Sanctions are clearly a tool to further strategic interests. They cannot work if imposed by a power that does not dominate the global trade system through its financial, trade, and monetary policies. The unsuccessful challenges to the dollar can be successful if the United States loses its economic power, financial influence, alliances with other Western nations, and regulative control over global trade. But none of this is expected any time soon.