Petrodollar

Petrodollar or petrocurrency refers to the US dollar traded for worldwide crude-oil exports. It facilitates the investment of export gains as the dollar is the world’s reserve currency. Moreover, the petrodollar history dates back to the US-Saudi agreement in the 1970s (including the recycling of additional oil profits), and the system is still strong defying the rumors of possible collapse.

Petrocurrency emanated from oil-supplying countries relies on the quantity and retail price of oil sold overseas, depending upon oil extraction. Furthermore, the oil-exporting nation may “recycle” the surplus oil proceeds back into their national economies or invest them into the American economy.

• The petrodollar implicates the US dollar rendered to the oil-exporting nation for international trade.
• It originated from the US-Saudi Arabia agreement in the 1970s, whereby the US provided weapons support to Saudi, and the latter started conducting its crude-oil sale in US dollars.
• Though the Chinese yuan might be a strong replacement, the petrodollar collapse is a far less likely future event.
• Petrodollar recycling indicates redirecting the excess US dollars back into the economy of oil-exporting countries, lending it to other nations, or investing in US economies.

The petrodollar emerged after the eradication of the gold standard on a global scale. As it is denominated in US dollars, its buying power depends upon the US inflation rate and (if required) exchange rate in the worldwide stock market. Any financial or other elements equally influence the petrocurrency and US dollar, creating pertinent legislative and commercial consequences.

In the Bretton Woods Convention (1944), other nations signed to peg their currencies to the US dollar. Nevertheless, US President Richard Nixon withdrew the dollar from the gold standard on August 15, 1971, because of stagflation. In 1973, the Organization of the Petroleum Exporting Countries (OPEC) surged oil pricing within a brief timespan.

Petrodollar recycling denotes the outflows worldwide via the usage of oil receipts by the petroleum exporting countries. Moreover, it transpires through the absorption channel and the capital account channel. Therefore, both mediums are crucial to evaluate the boost in oil revenues on worldwide imbalance.

The former utilizes petrocurrency to fund domestic investment and expenditure, therefore soaring the demand for importing products and utilities. While the latter uses petrocurrency unspent on imports to safeguard foreign assets held overseas, leading to the capital account discharge.

The US-Saudi Arabian Joint Commission on Economic Cooperation was instituted in 1979. It aimed to help Saudi evolution while recycling petrocurrency and enabling the flow of American machinery, goods, and utilities through excess oil earnings.

The petrodollar history stems from the Soviet Union's breakdown (1991), following which the US became the only superpower throughout the materialized unipolar world. Subsequently, the world observed several destabilizations and crises to sustain the leadership of the petrocurrency structure.

The term emerged in 1973 when the US agreed to offer armed protection to Saudi Arabia. It also provided weaponry and other military supplies in an agreement involving the overall sale of oil in US dollars. Moreover, Saudi Arabia would recycle the surplus dollars into the American economic system using US treasury bills and bonds.

By 1975, all OPEC members embraced the petrocurrency arrangement and consented to oil export in US dollars. As a result, the American currency now contributes to almost two-thirds of the international economy. It is the reserve currency for most central banks worldwide since the US dollar is the chief currency needed for natural gas and oil trading.

To clarify, here are some instances of the petrodollar system to understand its history and modern context.

Example#1

If US president Joe Biden continues imposing targeted financial sanctions, Russia might consider moving away from the dollar-denominated oil-exporting agreements. Moreover, the Russian Deputy PM Alexander Novak said this shortly after the nation declared full removal of US dollar assets from the Russian national wealth fund.

Since 2014, the Russian economy has been functioning under global sanctions following the seizure of Crimea. Consequently, Rosneft (the nation’s biggest oil firm) fixed the euro as the default currency for new oil exports to safeguard it from the influence of US sanctions.

Example#2

The Kingdom of Saudi Arabia (KSA) plans to conduct future oil deals with China using the Chinese yuan. According to Dow Jones and Wall Street Journal, both countries are in talks to make a few yuan-priced oil deals. However, the shift to yuan will be painful and expensive for Saudi Arabia.

Being the largest crude oil importer worldwide (1.76 million barrels per day), China provides some attractive incentives to KSA. It has also explored relevant collaborations with Saudi Arabia offering support to build nuclear missiles and heavily investing in the KSA projects. Irrespective of this probable shift’s success, it is a major step in history toward the shift from the petrodollar.  

There are various things to consider while discussing petrodollar collapse. Moreover, the recent geopolitical instances in Ukraine have demonstrated a highly possible end to America’s monopoly in international affairs. By Quarter 1, 2020, just 46% of Russo-China bilateral dealings were conducted in US dollars. Global warming concerns and a shift toward increased sustainable energy diminish the oil demand. So, a new financial structure for foreign investments avoiding petrocurrency and expensive externalities might be possible.

Nonetheless, almost 90% of foreign currency dealings are in US dollars. This accounts for 60% of forex reserves despite the country only contributing to nearly 20% of worldwide gross domestic product (GDP).

The US utilizes the strength of petrocurrency for its international policy impositions because various countries don’t fight back owing to their anxiety over the petrodollar termination. Hence, the end of petrocurrency is a very improbable forthcoming event due to its liquidity and unavailability of another substitute.

This has been a guide to Petrodollar and its Meaning. Here we describe the petrodollar system, its history, recycling, possible collapse, and examples. You can learn more from the following articles -

• Dollarization
• Currency Peg Example
• Cost-Plus Contract
• Sovereign Debt