Saudi-China Relations and Oil Trade in yuan

Recent discussions about China potentially paying for Saudi oil trade in yuan have fueled expectations that China’s significant oil imports from Saudi Arabia could increasingly be priced in the Chinese currency. Saudi Arabia raises Asia oil price as volatility grips market. However, yuan-based oil trade between the two nations faces substantial obstacles and may take decades to reach a significant scale. Despite these challenges, the deepening of bilateral relations and the alignment of long-term interests between the two countries could help support and accelerate this transition over time.

The yuan’s use remains limited in Saudi-China oil trade

Discussions about the potential for yuan-based oil trade often center on the ability to pay in yuan. However, merely having the ability to settle transactions in yuan is unlikely to drive its wider adoption. The key factor is whether oil exporters are willing to accept the currency, which largely depends on their ability to use the proceeds effectively. Oil surges to a premium of $2.20 a barrel above the Dubai/Oman benchmark.

Since the yuan is not widely used in global trade and finance, there are limited ways to spend these proceeds. Accumulating large inflows of yuan could lead to significant costs and heightened currency risks. This explains why, despite Saudi Arabia's openness to discussing yuan-based trade and China's desire to promote its currency, the use of yuan in Saudi-China oil transactions remains limited.

This situation may evolve, as President Xi Jinping's visit to Saudi Arabia in December 2022 initiated a shift in Saudi-China relations from one centered primarily on oil to a more comprehensive partnership. Beyond their strong oil trade relationship, long-term initiatives such as Saudi Arabia’s Vision 2030 are fostering new institutional, financial, and cultural connections between the two nations.

These expanding linkages may create more opportunities for the yuan to be used, such as paying for Chinese engineering and construction services in Saudi Arabia or investing in Chinese companies and projects across various sectors. As bilateral ties deepen, these channels could gradually support increased use of the yuan in Saudi-China oil trade over the coming decades.

Major obstacles that yuan-based oil trade are facing

China's push for yuan-based oil trade with Saudi Arabia began during President Xi Jinping's first visit to the kingdom in January 2016. Two years later, in March 2018, China launched its first yuan-denominated crude oil futures contracts on the Shanghai International Energy Exchange. This marked the creation of a yuan-based oil pricing system, offering an international benchmark to compete with the U.S.’s West Texas Intermediate and London’s Brent crude.

Despite these early initiatives, progress in yuan-based oil trade between China and Saudi Arabia has been limited due to significant challenges that undermine the economic feasibility of such trades. One of the primary obstacles is the yuan’s limited use in global trade and finance. Trading oil in yuan exposes oil exporters to additional risks, such as currency volatility and liquidity concerns,

Moreover, most major oil exporters, including Saudi Arabia, maintain substantial trade surpluses with China. If these nations were to conduct all oil transactions in yuan, they would accumulate far more yuan income than they could spend. While some of them could be invested or held, a large portion would eventually need to be converted into other currencies, leading to added costs and exchange rate risks. This dynamic continues to limit the appeal of yuan-based oil trade despite China's efforts to promote its currency.

The Chinese yuan is heading into global trade

The yuan has made substantial progress since its global launch in July 2009, when the pilot scheme for yuan cross-border settlement in Hong Kong was expanded to corporates, which introduced the yuan as a currency for international trade.

Since then, the People’s Bank of China (PBOC) has focused on promoting the yuan’s international use through two primary channels. The first involves expanding trade and establishing bilateral clearing and settlement infrastructure to facilitate the use of the yuan in cross-border transactions. The second channel focuses on developing and deepening offshore yuan markets, allowing international participants greater access to China’s financial markets.

China has made significant progress through the first channel. Its share of global trade has tripled over the past two decades, rising from 4% in 2002 to 13% in 2022. This growth in trade has widened the scope for using the yuan in international settlements. As a result, the currency's share in cross-border trade settlement has also tripled during this period, increasing from less than 1% in 2012 to over 3% in 2022.

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