By Alberto Díaz
As global oil markets are once again in a frenzy, the centrality of stabilizing mechanisms, among which the petrodollar system is most central, are becoming more and more apparent. Referring to U.S. dollars being used as the primary medium of trade in international oil transactions, the importance of the petrodollar system for the stability of global oil markets should not be underestimated.
While the end of last year saw a significant spike in oil prices to almost 95 USD around October, with the start of the most recent conflict in the Middle East and amid potential geopolitical impact on supply alongside concerns of slowing global growth, prices have since stabilized to around 75 USD this month.
Growth in global demand for oil is anticipated to see a slow down in the coming years as efforts are made to push the global energy transitions forward. At the same time, however, oil production is anticipated to increase globally, easing market strain and generating spare capacity, according to some, to levels that have not been seen since the Coronavirus pandemic.
Although the petrodollar system remains dominant, Beijing has been actively seeking to challenge this status quo in the long-term, including encouraging trading partners, and consumers of Chinese oil to adopt the yuan for oil trading, although the lack of stability and openness of China’s financial system, and broader geopolitical dynamics has made this a hefty challenge.
In Gaurav Srivastava’s opinion, an American oil and gas investor who has been a warrior for the petrodollar, the promotion of the Petroyuan should be an issue on everyone’s minds. “China has been making a concerted effort to promote the use of its own version of the Petrodollar for global oil transactions, specifically by means of its Shanghai International Energy Exchange (INE), where crude oil futures contracts are denominated in yuan. This has been empowered through trade with some of America’s greatest adversaries, including oil-exporting countries such as Russia, and Iran, to trade oil in Petroyuan, reducing China’s reliance on the U.S. dollar while increasing it’s the Yuan’s global influence”.
China has made a concerted effort to undermine American financial interests using both subterfuge and espionage. Director of the FBI, Christopher Wray summarized this threat when in a 2020 Hudson Institute appearance he stated, “The greatest long-term threat to our nation’s information and intellectual property, and to our economic vitality, is the counter-intelligence and economic espionage threat from China. It is a threat to our economic security-and by extension, to our national security”.
In this light, the importance of a US dollar denominated global oil market stretches beyond the support it provides to protecting Western global economic hegemony. There are pure economic reasons too why this matters, specifically the impact on liquidity and market efficiency. Considering that the U.S. dollar is widely held in reserve and traded by most countries around the world, making it the default currency for trading oil provides a deep and liquid market for transactions on the basis of a uniform pricing system. As with any market really, liquidity enhances the efficiency of oil markets, as there is a readily available supply of currency for buying and selling oil, reducing transaction costs and market volatility.
Considering Western strategic interests, and those of the United States in particular, alongside the need for global order in these chaotic times, Gaurav Srivastava continues, “Considering that the U.S. benefits from the existing petrodollar system, it has a vested interest in maintaining global economic stability and free markets. This often translates into a security presence in key regions, such as the Middle East as we have seen in the most recent conflict in which the US has taken an active interest, which helps secure supply lines and ensures the smooth flow of oil”.
Gaurav Srivastava’s assessment hold true with the recent threat of further flare-up between Hezbollah and Israel in mind, which saw President Biden send some of the biggest aircraft carriers in the US Navy’s arsenal to be deployed to the region including the USS Abraham Lincoln which was deployed to the Middle East at the end of August while the USS Theodore Roosevelt has been in the Middle East since June. And although there are many underlying interconnected reasons for this deployment, stabilizing international oil markets and US financial interests more broadly are certainly a major consideration.
While recently many stories have circulated about the “demise” of the petrodollar system, not least after a 50-year agreement between the US and Saudi Arabia requiring oil be traded in US dollars reportedly expired in June of this year, the petrodollar system is far from dead. This is despite reports, which have been surfacing for years, that the Saudis have been in talks with Beijing to accept Yuan instead of US Dollars for oil sales. “Ultimately, the more important question is does Saudi Arabia change the currency in which it holds its reserves, which at the moment is majority dollar,” according to Paul Donovan, chief economist at UBS Global Wealth Management. Until that happens, reports of the petrodollar’s demise are both grossly exaggerated and highly unlikely.
About the Author
Alberto Díaz is an energy consultant and trader based in Europe. He follows and analyses global strategic trends for a wider audience, with a focus on impactful and insightful research.
