Position: Long Lukoil (LUKOY), CNOOC (CEO)
After China and Russia announced in late November that they will no longer use the US dollar to conduct bilateral trade, last Wednesday marked the official start to trading the Yuan against the Ruble on Moscow’s Micex exchange. (China allowed the Yuan to trade versus the Ruble on its interbank market beginning on Nov. 22). China’s Ambassador to Moscow Li Hui said, “No doubt this will become a serious catalyst for economics and trade.”
Indeed. However, we’d note that the move is not a geopolitical game-changer; certainly it does represent concerted action by two global heavyweights following months of rhetoric that the USD must be replaced as the world’s global reserve currency.
Yet given this diversification away from the USD, we still don’t see another currency (or commodity) that’s a close second as an immediate replacement - certainly talk of the Euro as the new stalwart died hard alongside Europe’s sovereign debt crisis that came to a head in the first half of the year. While we’re quick to point out that the US will have its days of reckoning (following Europe) in dealing with its own fiscal imbalances, which should weigh to the downside on the USD, we’re not of the camp that the USD is going to the wayside as the world’s reserve currency anytime soon.
However, from a local perspective, the opening of the RUB-CNY currency cross (in both countries) should equate to an increase in trade between the two in the coming years, a relationship built on mutual needs: in particular energy long Russia is well equipped to provide for energy short China and Russia benefits from “cheap” consumer and electronic goods from China.
Further, as the Yuan is more freely traded against the currencies of its trading partners and the USD is removed as the “third-party” currency, mutual benefits are provided to both importers and exporters as transaction costs are reduced.
As of 2009, China’s total exports to Russia accounted for 2% of its global exports, and Chinese imports from Russia accounted for ~ 1.5% of its total imports. While Russia does not offer an individual breakout of its imports or exports by country, Russia’s trade with China (exports plus imports) makes up about 9.6% of its total trade. For comparison, Russia’s next largest trading partners are the Netherlands (9.6%) and Germany (8.3%). From a regional perspective, Russia’s largest trading partners are the Eurozone (49.5%) and CIS (13.7%), a consortium of former Soviet states.
Clearly the data suggests there’s a long runway of upside potential in Russian-Chinese trade relations. In early 2009 we wrote about a $25 Billion loan-for-oil agreement between both governments as a catalyst for the beginning of a greater partnership. In that deal, the Development Bank of China lent Russia’s state-owned energy companies the funds to build out their infrastructure, including a 41-mile pipeline extending from a refinery on the East Siberia Pacific Ocean to the Russian-Chinese border town of Xing’an with an annual capacity of 15 million tons of oil, expected to come online in January 2011.
While Russia provided China with 6.5% of its total oil imports in 2008 and 7.8% in 2009, this new pipeline has the potential to double the volume of Russian oil deliveries to China!
As both countries can better leverage each other, we like the mutual gains that each will enjoy. In particular, if Russia can continue to bring in Chinese capital it will support not only development in its dominant energy and commodity sectors, but also encourage economic diversification, an aim voiced loudly by the Kremlin over the last two years. On the other hand, cash-rich China can improve energy channels through strategic financing and acquisition deals to better supply its economic expansion, while capturing (in some cases) price security and future leverage against its other energy suppliers.
From an investment perspective, we see opportunities in this symbiotic relationship. In the Hedgeye Portfolio we’re currently long Russia’s Lukoil (LUKOY) and China’s CNOOC (CEO). If you’d like to learn more about our energy research, headed by Lou Gagliardi, please contact .
Matthew Hedrick
Analyst
