Are PetroDollar Days Numbered?

HISTORICAL PERSPECTIVE

Historically, crude oil has been traded in US dollars around the world. This began after WW II when the US dollar emerged as the primary currency for international trade.

Then in 1973, Casey Research describes how "the U.S. concluded a series of agreements with Saudi Arabia, the world’s leading oil producer, whereby America would prop up the Saudi ruling family with the latest in military and technical support, and in exchange the Saudis would commit to pricing their oil only in dollars. The 'petrodollar' was born.

With Saudi Arabia the de facto leader of OPEC, the rest of the countries in the cartel quickly followed suit. And so the situation has remained, with oil traded only in USD. The futures market reflects this reality, as well as New York’s NYMEX; even London’s International Petroleum Exchange prices oil contracts in dollars.

The emergence of the petrodollar simplified the buying and selling of oil, the world’s most indispensable commodity, and the USD became nearly every foreign country’s second currency. So obtaining dollars to buy oil, or for any other purpose, was a routine matter for most of them. If an Indian buyer wanted Kuwaiti oil, but Kuwait expected dollars (not rupees) in payment, no problem. The Indian company could obtain the needed dollars through trade with the U.S. or by buying them on the foreign exchange (FOREX) market.

But from the U.S.’ point of view, such simplification is a secondary benefit. Everyone needs to import oil, save those few nations that produce enough on their own. Therefore, everyone needs USDs to pay for oil. The real importance of the petrodollar system to the U.S. lies in reinforcing the dollar’s position as the planet’s common currency. Which the government can print as much of as it wants, at no cost. Such a deal!"


TODAY'S PROBLEM AND REACTION

With the weakening US dollar over the last several years, however, oil exporting countries have become unhappy. International analysts have hinted that it is only a matter of time before OPEC starts to price crude oil using a currency basket, rather than the US dollar. Recent actions include:

---Kuwait, Syria, Iran and Iraq have all de-linked their currencies from the US dollar.

---Suadi Arabia took the first step toward breaking its link to the US dollar when it failed to match the Federal Reserve's interest rate cuts in September.

---Venezuela, UAE, Kuwait and Qatar all carry out their oil trade in US dollars, and then immediately convert the proceeds to Euros.

---Iran recently signed a deal to sell crude oil to Japan using yen. Separately, Iran claims that 60% of its oil exports are settled in Euros.

---Russia has announced that it is planning to make the ruble internationally convertible and is organizing a native bourse, in which their vast natural resources could be traded in its own currency.


EXAMPLE OF PRICING IN EUROS

While crude oil prices have been soaring, the increases are muted when looked at in other currencies such as the Euro.

From the lows of early 2006 to the peak this week, the price of crude oil rose from $59.25 to $93.53. This is an increase of 58% in US dollars.

But when measured in Euros, the increase is much smaller. During this same timeframe, crude oil only increased from 49.90 Euros to 64.80 Euros. This is an increase of 30%, or half of the increase when measured in US dollars.


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Crude oil price as measured in Euros