Saudi Arabia & China in talks over yuan-denominated oil contracts, petrodollar under threat?

Saudi Arabia are again in talks with Beijing to launch yuan-denominated oil contracts, in yet another episode bound to shake up the geopolitical climate and one that could have serious implications for the status of the US dollar.

Negotiations between Saudi Arabia and China regarding swapping from dollar to yuan-based oil contracts have been occurring here and there over the last six years, however this round of talks arrive at a time when the political climate is especially delicate.

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Relations between the Saudis and the US have soured; last week, White House officials were unsuccessful in attempting to arrange a call between Biden and Saudi Arabian leaders, despite the success of both Russian president Putin and Ukrainian president Zelensky in achieving the same. The Kingdom is unhappy at the Biden administration’s actions regarding the nuclear deal in Iran, as well as diminishing American support of the Yemen war. These developments also come not long after Biden’s presidential campaign, during which he criticised the alleged role of crown prince Mohammed bin Salman in the death of journalist Jamal Khashoggi.  

Whether the yuan pricing remains just a threat, or whether there is something more tangible here, remains to be seen. However, should the move materialise, the ramifications for the US dollar would be stark. Oil contracts have been priced exclusively in dollars since 1974, when the Nixon administration struck a deal with the Saudis. Given WSJ report that over 25% of the oil that Saudi Arabia exports is sold to China, the move can be seen as an assault on the US dollar’s status as the world’s reserve currency. The yuan had weakened 0.3% during US trading, before the report on Saudi Arabia boosted it up 0.4%. This move also comes against the backdrop of a week of turmoil in Chinese markets, when the yuan had fallen 1.1% in three days (worst drop in over a year).

With the recent Russian and Iranian sanctions highlighting just what a weapon the US dollar is, the timing is poignant for an updated round of discussions on yuan-priced oil contracts. WSJ stated in the same report that the Saudis are also considering “yuan-denominated futures contracts, known as the petroyuan, in the pricing model of Saudi Arabian Oil Co., known as Aramco”.  

Any reduced exposure to the dollar would be enthusiastically celebrated in China, who no doubt are concerned at their vulnerability to the US given the treasuries they hold. The White House are very cognizant that China holds more US debt than any other country, a key variable in any analysis on the US dollar. And we have not even mentioned the elephant in the room – US money printing. Any lessening dependence on the dollar from China would be of grave concern to the US. A world without the petrodollar would tank demand for US treasuries, which given the rate at which the Fed has been buying them up over the last few years, could be catastrophic. What if yuan-denominated oil contracts are agreed and, simultaneously, China starts dumping their US treasuries? The US would likely have no choice but to ramp up money printing even further to monetise the debt.

Of course, guessing what the regimes of Saudi Arabia and China will end up doing is a fool’s game. The likelier scenario is that this simply remains a threat. The move would be incredibly aggressive by the Saudis, and would come with real risk on their behalf, too. Their currency, the riyal, is pegged to the US dollar and thus would feel the brunt of any depreciation. It could lead them to pinning it elsewhere, or to a basket of currencies, but the uncertainty could shake their economy to the core.

But threat or no threat, Saudi Arabia will no doubt be watching with trepidation at how the US have weaponised the dollar, raining restrictions down on Russia and Iran. With China eager to swap to yuan and reduce their own dollar exposure, it must be tempting to the Saudis to at least sell a portion of oil to them in yuan. Why wouldn’t they want to diversify their dollar risk?

Whatever happens, the US dollar’s status as the world’s reserve currency has certainly never felt shakier.