Over the past several years, and particularly after the start of the Russia-Ukraine conflict, suggestions about trading oil in non-USD currencies, especially the renminbi, have notably increased. Talks have mainly been ongoing between China and other major emerging markets, however at the BRICS summit in August this year, some members of the BRICS group, which comprises Brazil, Russia, India, China, and South Africa, have also emphasized their intentions to increase direct local-currency transactions between member states.

For some market participants, recent developments appear to have increased the potential attractiveness of trading oil in renminbi. These include the changing relationship between the U.S. dollar and the Brent oil price, more expensive trade financing in the U.S., and, in some cases, sanctions and geopolitical concerns. Yet, we believe that a widespread switch of oil trades from U.S. dollar to renminbi is unlikely, at least in the near-term future. The main challenges include the fact that the renminbi is not a freely traded currency, the peg of oil-exporting Gulf economies' currencies to the U.S dollar, and current market dynamics that may prevent importers from benefiting from renminbi-denominated trades.

Renminbi-Denominated Oil Trade: The Pros

The first argument for trading oil in non-USD currencies could lie in the recent increase in USD-denominated trade financing costs, which results from the high interest rate in the U.S. The U.S. interest rate currently exceeds the interest rates of other developed markets and China and is at its highest point since 2017, which increases USD-denominated trade financing costs. We currently expect another hike from the current rate of 5.375% (mid-range; see "Economic Outlook U.S. Q4 2023: Slowdown Delayed, Not Averted", Sept. 25, 2023).

Another argument in favor of trading oil in non-USD currencies could consist of the changing relationship between the U.S. dollar and oil prices. Historically, the correlation between the U.S. dollar and oil prices was negative, meaning that an increase in oil prices was associated with a weakening of the U.S. dollar and vice versa. Since oil is almost exclusively priced in USD, this relationship was generally beneficial for commodity importers because it provided a partial hedge against increasing oil prices. When oil prices surged, the local currencies of oil-importing economies typically appreciated against the U.S. dollar. Yet, this trend has changed notably in the past few years (see charts 1.1-1.2) when a strengthening of the U.S. dollar was often accompanied by an increase in oil prices.

Chart 1.1

Chart 1.2

Two factors contributed to the inverse relationship between the U.S. dollar and oil prices over 2021-2023.

Firstly, the U.S. dollar strengthened in 2022 because of rises in interest rates, which increased by more than 500 basis points since March 2022, and, secondly, a surge in market volatility in the wake of the Russia-Ukraine conflict. However, there are some changes that may potentially be of a more structural nature, due to changes in the export dynamics of U.S. oil (BIS, 2023).

Potential structural changes to the USD/Brent relationship

Two structural changes contributed to the recent change in the U.S. dollar/oil price correlation. Firstly, the U.S. recently experienced a boom in shale oil extraction as total oil production increased to about 12 million barrels per day (bbl/d) in 2022, from about 5 million bbl/d in 2005. Secondly, the U.S. government lifted its 40-year ban on oil exports in 2015. These changes meant that the U.S became a net oil exporter for the first time since the late 1940s (see chart 2). Based on our expectation that global crude oil prices will remain relatively high, it means that shale oil production will continue to be profitable and that the U.S. will likely remain a net exporter in the near-term future. Positive net energy exports alleviated some of the pressure on terms of trade and, subsequently, the U.S. dollar, which represented a notable shift from the period before 2021.

Chart 2

The positive correlation between the U.S. dollar and oil prices has a major effect on commodity importers. For example, when the U.S. dollar appreciated in tandem with an increase in oil prices in 2022, importers incurred significantly higher import costs in their domestic currencies (see chart 3). This can have significant implications for economic growth, fiscal balances, and inflation, especially considering that the positive USD/oil price correlation may persist in the future.

Chart 3

Implications Of The Positive USD/Brent Correlation

Other currencies, such as the euro and the renminbi, are still negatively correlated with oil prices. Therefore, purchasing oil in non-USD currencies may potentially alleviate some costs that arise from depreciating domestic currencies.

Oil price and exchange rate dynamics over the past few years demonstrate the potential differences of trading oil in renminbi (see chart 4). We used Chile as an example--although the results are broadly similar for other emerging markets--and calculated year-on-year oil price changes in U.S. dollars, in the domestic currency when converted from U.S. dollars, and in the domestic currency when converted from renminbi for 2021-2023. The oil price in U.S. dollars is based on historical data. We assumed that day-to-day oil price changes in renminbi are similar to those in U.S. dollars. Chart 4 shows that renminbi-denominated oil trades might have been cheaper in 2022 in domestic currency terms, due to the depreciation of the renminbi in 2022. This was particularly the case between June and August when the difference between USD- and renminbi-denominated oil trades was up to 20 percentage points in year-on-year terms.

Chart 4

Yet, we do not expect that emerging markets will take advantage from possibly beneficial exchange rate dynamics between the U.S. dollar and the renminbi, given current market conditions.

Renminbi-Denominated Oil Trade: The Cons

The main obstacles against trading oil in renminbi are its limited internationalization and the fact that the current USD-dominated market structure may prevent oil importers from capitalizing on the negative correlation between oil prices and the renminbi. We expect that trading oil in renminbi will likely be associated with exchange rate risks and currency costs, meaning that renminbi-denominated oil trades would come with a price premium. We identified five main challenges against trading oil in renminbi.

1 – The renminbi is not a freely traded currency

Since the renminbi is not fully internationalized, trading in the currency will complicate matters for oil exporters and importers alike.

In the case of exporters, the risks stem from uncertainty about the usability of renminbi-denominated revenue. If exporters cannot invest renminbi-denominated revenue, for example because renminbi-denominated assets are not available, they will be forced to exchange renminbi into other currencies and, therefore, incur exchange rate risks and costs. While it is true that oil exporters can use renminbi-denominated revenue to purchase goods and services in China, major hydrocarbon exporters tend to have remarkably positive trade balances with China (see chart 5). Energy exporting nations import less from China than they export to the country. Therefore, exporters will still have to convert a significant share of their renminbi-denominated revenue into other currencies.

For importers, trading oil in renminbi comes with funding risks that result from the currency's lack of internationalization and the relatively shallow RMB capital markets.

Chart 5

The increasing usage of the renminbi internationally or its emergence as a global reserve currency would mitigate most of these risks. But even though a gradual internationalization of the renminbi is likely, Chinese policymakers appear in no hurry to remove capital account restrictions and the prospective timeline of the internationalization process remains unknown. The internationalization of the renminbi requires several steps, including a higher use of the renminbi in foreign exchange markets, more flexible capital accounts, and a sustained account deficit (see "Economic Research: Four Checkpoints On The Path To Greater Renminbi Internationalization," July 10, 2023).

2 – Gulf exporters' currencies are pegged to the U.S. dollar

Many oil exporters that sell oil to China--particularly Gulf exporters, including Saudi Arabia, the UAE, Iraq, Oman, and others--peg their currencies to the U.S. dollar. Trading in renminbi therefore exposes them to exchange risks. If the U.S. dollar appreciates, selling oil in renminbi may potentially decrease these countries' domestic-currency-denominated revenue, unless they add a significant premium to renminbi-denominated oil trades.

3 – Even if some emerging markets switch to the renminbi, most oil trades will continue to be USD-denominated

China is the largest global oil importer, but developed economies still import more oil than the entirety of emerging markets (see chart 6). Currently, we do not expect that any developed economy, be it an EU member state, Japan, South Korea, or Canada, will stop trading oil in U.S. dollars. This means some market participants' switch to the renminbi would have little to no effect since the majority of international oil trades would still be USD-denominated. As a result, renminbi-denominated oil prices would likely emulate USD-denominated oil prices and make it hard for oil importers to benefit from exchange rate dynamics.

Chart 6

4 – The emergence of the renminbi as a major currency for trading oil could alter the current correlation between the renminbi and oil prices

Considering the low degree of the renminbi's internationalization, the development of exchange rates in the case of changing oil prices is unclear. An increase in oil prices would increase the demand for the renminbi--because more currency is needed to purchase oil--and could lead to an appreciation of the currency, given the potentially high share of renminbi-denominated oil transactions globally. This would incur additional costs on oil importers. Yet, the Chinese government might intervene to limit currency appreciation, as it also happened before.

5 – The correlation between the U.S. dollar and oil prices could become less positive

As mentioned above, the surge in oil prices in 2022 coincided with unique factors, including the Federal Reserve's monetary tightening and significant market volatility. This means a wind-down of monetary tightening activities might make a lockstep appreciation of the U.S. dollar every time oil prices rise less likely. We also note that the comparison of correlation patterns between now and before 2019 is hampered by the fact that the Federal Reserve's loose monetary policy in the 2010s might have driven the strong negative correlation we saw up to 2019.

A Switch To The Renminbi Would Likely Be Politically Motivated

We think the renminbi's current degree of internationalization, oil-exporting economies' currency pegs, and the dominance of the U.S. dollar make a switch to renminbi-denominated oil trades unlikely, at least for now. Trading oil in renminbi would incur significant conversion and transaction costs and impose funding and exchange risks on both exporters and importers. The emergence of the renminbi as a global reserve currency would tackle some of these issues, but the timeline for this remains unclear. In our view, if economies start trading oil in renminbi, they would rather do it for political, not economic, reasons.

Related Research

• Economic Outlook U.S. Q4 2023: Slowdown Delayed, Not Averted, Sept. 25, 2023
• Economic Research: Economic Outlook Asia-Pacific Q4 2023: Resilient Growth Amid China Slowdown, Sept. 24, 2023
• Economic Research: Four Checkpoints On The Path To Greater Renminbi Internationalization, July 10, 2023

External Research

• The changing nexus between commodity prices and the dollar: causes and implications; Bank of International Settlements, B.Hofmann, D. Igan, D.Rees, April 13, 2023