Is The Petrodollar Doomed?

The Russian invasion of Ukraine has had many global economic consequences, and one of them is increasing concern among some nations about the US petrodollar’s decades-long dominance of global trade in oil and gas.

The US decision to cut Russia off from the Society for Worldwide Interbank Financial Telecommunication, better known as SWIFT, and to freeze $350 billion of its assets due to the invasion heightened concerns about Washington’s control over the global financial system. Russia cried theft, and quickly refused to accept dollars, or euros for its oil and gas production.

China has also wanted to make the yuan a global rival to the dollar, something the world’s second largest economy has struggled to gain traction among friendly nations, who continue to use the dollar out of a position of convenience. The US sanctions on Russia suggest that dollar reserves may be risky for nations at a time of crisis, just when they are needed the most.

When Western countries froze Russian central bank reserves held in their banks, this was tantamount to “crossing the Rubicon,” as economist Adam Tooze wrote. “It brings conflict in the heart of the international monetary system. If the central bank reserves of a G20 member entrusted to the accounts of another G20 central bank are not sacrosanct, nothing in the financial world is. We are at financial war.”

Xi’s Visit

Using the dollar and sanctions as a foreign policy might have in the short term, but it could also threaten the dollar’s role as the world’s foreign currency reserve. Aware of this, President Xi Jinping said during a trip in December to Riyadh, where $30 billion in bilateral deals, that China would start paying for oil in yuan.

The Saudi government said it was open to the idea. The next month in Davos, Switzerland, Saudi Finance Minister Mohammed al-Jadaan said his country saw no issue in discussing oil trade in other currencies than the dollar.

"There are no issues with discussing how we settle our trade arrangements, whether it is in the US dollar, whether it is the euro, whether it is the Saudi riyal," al-Jadaan said in an interview in January with Bloomberg News in Davos, Switzerland. “I don’t think we are waving away or ruling out any discussion that will help improve trade around the world.“

Other countries have already started trading oil in other currencies.

Indian importers have paid for most Russian oil in non-dollar currencies since the Group of Seven economies, the European Union and Australia, imposed an oil price cap on Russia in December. Russia and India have used UAE dirhams and Russian rubles to trade oil.

Some Dubai-based traders, and Russian energy companies Gazprom and Rosneft are seeking non-dollar payments for certain niche grades of Russian oil that have in recent weeks been sold above the $60 a barrel price cap, Reuters reported, citing three sources it didn’t identify.

“Do take a step back and consider… that since the beginning of this year, 2022, Russia has been selling oil to China for renminbi, and to India for UAE dirhams,” Zoltan Pozsar, Managing Director in the Investment Strategy and Research department, at Credit Suisse in New York wrote. “India and the UAE are working on settling oil and gas trades in dirhams by 2023; and China is asking the GCC to ‘fully’ utilize Shanghai’s exchanges to settle all oil and gas sales to China in renminbi by 2025. That’s dusk for the petrodollar.”

The Petrodollar

The term petrodollar refers to the US dollar’s position as the primary worldwide currency for international oil transactions. This status was established in the 1970s as part of a pact between the US and Saudi Arabia in which the US committed to provide Saudi Arabia with military protection in exchange for the Saudi government agreeing to price all of its oil exports in US dollars.

The Saudis received protection from geopolitical enemies, and the US got a place to unload large amounts of government debt, according to the Auburn, Alabama-based Mises Institute. Saudi Arabia then parked dollars in relatively safe and reliable US investments in a process called “petrodollar recycling,” Ryan McMaken, a senior editor at the Mises Institute, wrote.

While there has been push back against the US dollar’s dominance, it is unlikely that it will be unseated anytime soon. The dollar plays a huge role in currency markets, with assets of the Eurodollar estimated at $12 trillion dollars, compared with $3.5 trillion in petrodollar assets, according to Mises Institute.

IMF data show that the share of global reserves denominated in US dollars represented 59.8% of reserves in the third quarter of 2022, compared with 59.2% in the year early period, according to the IMF.

Brazil, Russia, India, China and South Africa, the bloc known as BRICS, have discussed the creation of a BRICS payment system as they seek to reduce their dependence on the dollar. In 2015, China created the Cross-Border Interbank Payment System, run by the People’s Bank of China, which is gradually being used by other central banks.

Bank of Israel unveiled last year a new strategy for its more than $200 billion of reserves. Beginning this year, it will reduce the share of US dollars and increase the portfolio’s allocations to the Australian dollar, Canadian dollar, Chinese renminbi and Japanese yen, the International Monetary Fund said.

“We are seeing these previously very dollarized economies potentially turning away from trading in dollars and using US capital markets, but also looking for other ways to store reserves so that they can actually be accessed in a timely manner where they need to be accessed,” Simon Harvey, head of FX analysis, Monex Europe, said.

Despite this, it is unlikely that the dollar will lose its place as the world’s reserve currency in the near future, but “the rise of the renminbi and the euro as credible alternatives deserves particular attention,” Harvey said.