Growing Saudi-China relations may lead to yuan-based oil trade: S&P

Growing ties between Saudi Arabia and China could potentially shift oil trade between the two nations to the Chinese currency, the renminbi, according to a report by S&P Global.

Recent discussions about China paying for Saudi oil in renminbi have heightened expectations that a significant portion of the massive oil trade might soon be denominated in the Chinese currency. However, while the concept of yuan-based oil trade holds promise, it faces substantial challenges and may take decades to become significant, S&P noted.

The idea of settling oil trade in renminbi aligns with the strengthening bilateral relations between Beijing and Riyadh. These ties are bolstered by strategic interests, including Saudi Arabia’s Vision 2030, which aims to diversify the Kingdom’s economy beyond oil and build new financial and cultural connections with major global economies like China. This evolving relationship could provide more opportunities for the yuan’s use and gradually shift its role in bilateral trade.

Despite this, S&P Global emphasizes that the mere ability to pay for oil in renminbi is unlikely to lead to a significant increase in its use. A key factor is the willingness of oil exporters to accept the currency, influenced by their ability to utilize the proceeds. The renminbi’s limited use in international trade and finance presents challenges, including potential costs and currency risks.

This limitation helps explain why the yuan’s role in Saudi-China oil trade remains modest despite mutual interest. This dynamic may change as the strategic relationship between Saudi Arabia and China evolves.

President Xi Jinping’s visit to Saudi Arabia in December 2022 marked a turning point, shifting the relationship from one focused primarily on oil to a more comprehensive partnership.

Ongoing expansion of institutional and financial ties, driven by Vision 2030, could open new channels for the yuan’s use, such as payments for Chinese engineering and construction services in Saudi Arabia or investments in Chinese projects across various sectors. The introduction of renminbi-denominated crude oil futures contracts on the Shanghai International Energy Exchange in March 2018 was a notable step towards establishing a yuan-based oil pricing system. However, progress has been slow, primarily due to the yuan’s limited use in global trade and finance.

Most oil exporters, including Saudi Arabia, have currencies pegged to the US dollar, and the risks associated with converting yuan into other currencies have hindered broader adoption. The fluctuating exchange rate between the dollar and the renminbi presents additional challenges. If the dollar appreciates against the yuan, Saudi Arabia and other Gulf countries with dollar-pegged currencies could see reduced oil revenues in domestic-currency terms when traded in yuan.

Beijing has yet to address these issues comprehensively, and the absence of a clear roadmap for currency and capital account liberalization adds to the uncertainty surrounding the future of yuan-based oil trade, according to S&P.

The renminbi currently ranks as the third-most-used currency in SWIFT trade finance settlements, accounting for 5.3 percent of transactions, trailing behind the euro’s 5.9 percent and far from challenging the dollar’s dominant 84 percent share. Despite this, geopolitical dynamics, especially rising US-China tensions, have provided some momentum for the yuan as an alternative currency in global trade.

This trend is evident in Saudi-China trade, where oil’s share of China’s imports from Saudi Arabia rose to 84 percent last year, boosting the Kingdom’s trade surplus with China to between $20 billion and $40 billion in recent years, compared to $5 billion to $10 billion in 2015/2016.

The shift toward yuan-based oil trade may depend on non-economic factors, such as strategic and geopolitical considerations. The diversification of global trade relationships, particularly among emerging economies, has prompted some countries to explore alternatives to the US dollar.

During the BRICS summit in August 2023, member states expressed intentions to increase local-currency transactions, with some Gulf states, including Saudi Arabia, exploring non-dollar trade options to enhance economic diplomacy.

While challenges remain, incremental progress in yuan-based trade could occur, particularly in sectors other than crude oil, such as natural gas and other traded goods. The geopolitical landscape and strategic interests may gradually facilitate the yuan’s role, although it remains uncertain how quickly or extensively this will happen.

For Saudi Arabia, the prospect of renminbi-based oil trade is closely linked with its broader economic transformation under Vision 2030. The Kingdom’s ambitious plans, including diversifying its economy and establishing new international partnerships, could offer more outlets for spending yuan, such as investing in infrastructure projects like the $500 billion NEOM giga-city and collaborating with Chinese firms in sectors like renewable energy and manufacturing.

Saudi Arabia’s engagement with China could extend beyond oil trade, with significant investments in Chinese firms and projects offering additional avenues for utilizing yuan proceeds. While the potential for yuan-based oil trade exists, it is constrained by considerable economic and financial challenges.

The future of such trade will likely hinge on the evolution of broader strategic ties between the two nations, the development of new financial and institutional linkages, and the management of associated risks. As these factors unfold, the renminbi may gradually gain a more prominent role in Saudi-China trade, though it is expected to be a slow and uncertain process, according to the ratings agency.