A Profound Game Changer: Coming soon.

• Author: Leung, Chris

One of our predictions after the 19th Party Congress in October 2017 was the impending establishment of a petro-CNY system backed by gold. Evolving economic and geopolitical forces may well hasten this dynamic.

China is not only the largest exporter in the world. Its imports are the second-largest as well. China is the biggest net importer of oil in the world, surpassing the United States and Germany in 2016. For oil producers such as the Gulf states, Russia, and Venezuela, there is hardly any buyer as important as China. Settlement of oil in the Chinese yuan (CNY) is a natural course of development from Beijing's perspective.

THE RUSSIAN ANGLE

Sanctions on Russia by the United States since the Ukraine crisis have led to one important unintended consequence: They sped up wider acceptance of the CNY by Russian energy companies. Russia's fourth-largest oil producer in 2017, Gazprom Neft (the oil arm of state gas giant Gazprom), has been settling its entire crude sales (one-third of total oil sales) to China in CNY since 2015. Since the start of 2015, Gazprom Neft has been selling all of its oil exports through the East Siberia Pacific Ocean pipeline to China in renminbi. The second ESPO pipeline will be in operation by the end of 2018, with an annual capacity of fifteen million tonnes.

China is also exerting its influence via an acquisition strategy. CEFC China Energy recently acquired 14.2 percent of Russia's largest oil producer Rosneft for about US$9 billion. As part of the deal, thirteen million tonnes of Russian crude will be sold to the Chinese conglomerate per year, starting in 2018. That equates to 260,000 barrels per day, about 5 percent of Rosneft's output and one-quarter of China's monthly imports from Russia. And the deal would eventually rise to forty-two million tonnes (840,000 barrels per day). A substantial part of these crude sales, if not all, will likely be settled in CNY given the growing alliance between Beijing and Moscow.

In fact, a closed-loop petro-CNY system has already been working between China and Russia for some time, with Russian companies delivering oil products to China and using CNY as settlement currency. Russian companies either save or spend the CNY on Chinese goods and services. This system helps to relieve industrial overcapacity by creating long-term demand for Chinese-made capital goods. For instance, China Railway Group won the contract for the construction of Moscow-Kazan rail in 2017.

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