31 October 2012, 19:22

Russia and China to drive the world oil market

Russia and China to drive the world oil market

The global oil market is moving east, says a recent report by The Wall Street Journal Europe. The oil that Russia exports to China, Japan, South Korea, the Philippines, India, Indonesia, the USA and Peru could set the world’s new oil price standard. China stands ready to service the global oil trade with its Yuan, heralding the beginning of the end for the “petrodollar” era.

Russia's Asian partners currently buy oil from East Siberia based on the adjusted price of the US (WTI) and European (Brent) oil standards. But those classifications no longer reflect global supply and demand accurately. The price of Brent, for example, is rising due to the depletion of reserves in the North Sea while the WTI price is too low because of the USA’s oil surplus. The gap between the European and US prices is one of the key factors driving current uncertainty, which in turn disturbs the situation in the Asian oil market. 

Meanwhile, Asia’s oil consumption is consistently increasing, strengthening its hand to the point that will be able to determine the market within the next few decades. It would be reasonable for the region to expect oil price in its own dynamic market to be based on its own demand. It would therefore appear quite logical to take the type of oil extracted, and sold to local consumers, in Asia as the standard. ESPO (Eastern Siberia–Pacific Ocean) oil is pumped from the Kozmino port near Vladivostok to China via the East Siberia-Pacific Ocean pipeline. There is every possibility that ESPO could become a new world standard for oil pricing, believes Vladimir Feigin, head of the Institute of Energy and Finance; “The supply of oil goes up, a new kind of oil is created that is based on that supply. For a wide use of the new standard a number of exchanges are needed, where the prices would be set. That oil is supplied to the growing markets of Asia and the Far East and the volume is growing. That’s why this oil stands a good chance of becoming an acknowledged international standard.”

ESPO oil stands to be valued by Asian countries at the top pricing level. It exceeds many other sorts of oil, its extraction began fairly recently and the reserves are large. In addition, ESPO has to travel a shorter distance. While Middle East oil is delivered to the Asia-Pacific Region in two to three weeks, oil from East Siberia takes only 3-5 days. 

At the same time, China's growing demand for oil, as well as plans to increase the flow volume through the Russia-China pipeline, will allow it to avoid sharp price fluctuations for ESPO oil in the Asian market as a whole. Maximum price transparency and even volumes of delivery are key factors to ensuring energy security. Today’s volatility of the dollar exchange rate creates major risks for that security; Russia and China have come up with a proposal to respond to that challenge. On September 7, at the APEC summit in Vladivostok, Russia and China signed an agreement by which Russia agreed to sell oil to China, in any quantities, in exchange for payment in Yuan. A day earlier China had made another official statement; its banks, along with the whole telecommunications and bank transfer system, are able and willing to service any oil export-import operations, a feasible proposition considering that China already has currency swap agreements with about 30 countries and regions. 

Russia and China are well positioned to help Asia's energy market to break the long standing link between crude oil and the dollar, by which the price has always been tied to American, Middle Eastern and European standards by an increasingly volatile dollar. In essence a new link is on the table: Russian ESPO oil tied to the Yuan, where the oil price will, for the first time be determined by a stable supply from East Siberia and the growing demand in Asian countries. The Chinese Yuan is therefore well placed to become the new oil currency.

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