Mideast Gulf: Ready for Non-Dollar Trade?

The Issue

Western sanctions after Russia's invasion of Ukraine saw key Russian banks excluded from the dollar-denominated Swift financial messaging service and an estimated $300 billion of central bank assets frozen. Those actions gave new impetus to ongoing efforts by countries including China, India, Russia and Iran to create alternative payment and settlement systems. Chinese President Xi Jinping made a pitch for Mideast Gulf states to switch to the yuan for bilateral trade, including for oil, during a December visit to Riyadh.

Will They, Won't They?

Hydrocarbon-rich Gulf states have seen trade with China soar over the past two decades, and questions are emerging over why transactions are carried out in a third-party currency when a deep bilateral trade relationship exists. China has become Saudi Arabia’s largest trading partner, with volume between the two sides climbing above $81 billion in 2021. The kingdom was China's largest supplier of crude in 2022 at 1.76 million barrels per day. By contrast, Saudi exports to the US were just 435,000 b/d in 2022.

For Saudi Arabia and China, trading in their own currencies would make sense, some argue. And when Xi met with Gulf Cooperation Council (GCC) leaders in Riyadh in December, he was clear about China's offer. China “will continue to import large quantities of crude oil on a long-term basis from GCC countries and purchase more LNG” and the Shanghai Petroleum and National Gas Exchange (SHPGX) “will be fully utilized for RMB [renminbi] settlement in oil and gas trade,” Xi said. China is also interested in developing digital currencies that bypass the dollar.

“The crucial point is whether Mideast producers are happy to use the yuan,” a China-based source close to the Shanghai International Energy Exchange (INE) told Energy Intelligence. “Surely they are happy to have more choice, but there is no free meal. Maybe they want something in exchange, from the US or from China.” This could be Xi’s promise of “all-dimensional energy cooperation,” along with help in developing high-tech industry. As for the US, a Saudi aim could be to send a message to Washington that it has options. 

Saudi Finance Minister Mohammed al-Jadaan told Bloomberg TV last month that Riyadh was at least open to settling trade arrangements in currencies other than the dollar. “I don’t think we are waving away or ruling out any discussion that will help improve the trade around the world,” al-Jadaan said.

China has been promoting use of its currency for more than a decade, in part to increase, and mirror, its geopolitical influence, and to insulate itself from US monetary and sanctions policy. Oil has been difficult to penetrate because of the huge trading and hedging complex built around the dollar. Progress there seems to be accelerating as sanctions expand, with Russia, Iran and Venezuela now trading oil with China in yuan.

But Energy Intelligence understands there is no imminent plan for a major move by Gulf producers away from the dollar. Doing so would undermine the greenback's “safe haven” status, which would be problematic for Gulf states' own dollar-pegged currencies. The limited volume of yuan in the market is another concern. A partial switch, initially focused on non-oil trade, could be a starting point, however. “People are looking at the benefits and detriment of dollar trade,” says Theodore Karasik of Gulf State Analytics. “It's a sovereignty issue and I think that it is becoming a more serious policy issue."

China's Push

Western sanctions imposed on Russia have been a clear warning to the Chinese government of how its economy, and access to foreign reserves, could be strangled if a major crisis breaks out — for example, if Beijing were to invade Taiwan. More trade in yuan would help protect at least part of China’s economy from the US' reach.

Gulf producers settling more of their commodities sales in yuan would provide an incentive to pay for Chinese projects in their countries in yuan and to invest and trade more with China. But the use of China's currency in international trade remains limited. The yuan was the fifth most active currency for global payments by value in December 2022, according to Swift data, but its share is still at a low 2.15% versus almost 42% for the dollar and 35% for the euro.

New technologies in the form of central bank digital currencies (CBDCs) might be one way of facilitating non-dollar trade going forward. The United Arab Emirates participated in a pilot of China’s multiple-CBDC Bridge Project. Separately, India has paid for some Russian cargoes in UAE dirham. The Saudi Central Bank (Sama) has carried out research into CBDC use, launching Project Aber in collaboration with the Central Bank of the UAE in 2019 to focus on exploring “the viability of a single dual-issued digital currency as an instrument of domestic and cross-border settlement.” However, Sama has not publicly committed to rolling it out.

Early Days for Yuan Oil Trade

What Xi suggested in December to the GCC is to make full use of the SHPGX as a platform to carry out yuan settlement in oil and gas trade, rather than the INE, where China’s crude oil futures trade. The wording was also ambiguous — rather than saying the exchange could be used for settling physical oil transactions, Xi could have meant that yuan-based contracts for hedging physical deals would be developed on the exchange.

Saudi crude is typically priced as a differential to forward-looking prices. “Generally speaking, futures prices are more feasible as a benchmark,” the China-based source said. The INE's own forward-looking curve for the Shanghai medium, sour crude oil futures contract launched in 2018 meanwhile remains too limited to become a benchmark, with short-term Chinese speculators its main participants. So far the SHPGX only holds gas and LNG contracts that are not very successful, and no oil contract trades there.