Over the course of the last seven months, we’ve painstakingly documented the quiet death of petrodollar mercantilism, the USD recycling system and fixture of the post-war global economic order that has served to underwrite decades of dollar dominance. 

As a reminder, the petrodollar system works like this: oil export countries recycle the dollars they receive in exchange for their oil exports by purchasing more USD-denominated assets, boosting the financial strength of the reserve currency, leading to even higher asset prices and even more USD-denominated purchases, and so forth, in a virtuous (especially if one holds US-denominated assets and printed US currency) loop. 

The flow of petrodollar reserves into financial markets peaked in 2006 and turned negative for the first time last year when Saudi Arabia famously Plaxico’d itself (and the US) by glutting the world with crude, in an attempt to crush Putin, and subsequently, to take out the US crude cost-curve. 

And while the recent drawdown in oil exporters’ petrodollar reserves suggests Saudi Arabia’s actions were sufficient in and of themselves to catalyze the system’s demise, the US has accelerated the process by backing economic sanctions on Russia which, starting this year, began to settle oil and natural gas exports to China in yuan, marking what we have hailed as the  the intersection of two critically important themes that have far-reaching geopolitical and economic consequences: 1) the death of petrodollar mercantilism, and 2) the idea of yuan hegemony. 

In “The PetroYuan Is Born: Gazprom Now Settling All Crude Sales To China In Renminbi”, we argued that as economic ties between China and Russia deepen (thanks to billions in currency swap lines and the construction of the new Western gas line which will deliver an additional 30bcm/y to China on top of the 38bcm/y which will flow through the “Power of Siberia” line once operational) Beijing could increasingly look to Moscow to meet China’s energy needs. This would of course only serve to further de-dollarize the global energy trade, dealing yet another blow to the petrodollar system. Sure enough, Russia has, for the first time in history, overtaken Saudi Arabia as China’s top oil supplier. FT has more:

Russia was China’s largest supplier of crude oil for the first time on record in May, as Moscow looks beyond Europe for customers and grows its ties in the east.

The country leapfrogged Saudi Arabia, the world’s largest oil exporter, sending almost 930,000 barrels a day to China, up 21 per cent since April, according to customs data published on Tuesday.

Sino-Russian ties have warmed as sanctions over the conflict in Ukraine have strained Moscow’s relations with the west.

Analysts said the data were the result of a string of oil-for-loan deals that China, which is in the process of overtaking the US as the world’s biggest importer of crude, has signed with Russian oil companies including state-backed Rosneft.

“Russian imports are likely to stay high over the next several years as these long-term crude supply contracts kick in,” said Amrita Sen, head of oil research at Energy Aspects in London.

“By our records, which started in 2007, this is the first time Russia is China’s top crude supplier,” she added.

 

“This trend only depicts the inevitable problem that Middle Eastern producers are going to face in China,” said Ed Morse, Citigroup’s global head of commodities research.

Loan-for-oil deals with Russia, as well as other countries such as Brazil, will “make it more difficult for Saudi Arabia, Iraq and others to compete for market share in China”, he added. Additional oil from Iran if sanctions are lifted will only increase the struggle.

Make no mistake, Europe's move to extend economic sanctions on Russia into next year and the recent attempt by Belgium, France, and Austria to freeze Russian assets in an effort to enforce the unenforceable Yukos settlement, serve to drive Russia and its vast energy reserves further away and provide more incentives for Moscow and China to de-dollarize the global energy trade, facilitating both the demise of the petrodollar and the ascension of the yuan in the process.