By Frances Coppola
The story of king dollar goes back to 1973, when war in the Middle East disrupted global oil supplies and triggered a sharp rise in U.S. inflation. Stabilizing the Middle East and gaining effective control of oil reserves became a top priority for the U.S. There followed a series of bilateral deals between the U.S. and Saudi Arabia, in which the U.S. offered military support in return for Saudi Arabia invoicing oil in USD. In 1975, Saudi Arabia persuaded the rest of OPEC to invoice oil sales in USD.1 U.S. dollars earned through the sale of oil became known as "petrodollars."2
Creating a link between the dollar and the oil price effectively replaced the prior peg to gold and helped to stabilize the dollar's exchange rate. That USD-oil link also ensured that there would always be international demand for the dollar, helping to prevent speculative attacks on the currency.3
Today, China is the world's largest importer of oil. In 2017, it imported 8.4 million barrels of oil per day; the second largest importer, the U.S., imported 7.9 million.4 At present, China pays for its oil imports in U.S. dollars, which it draws from FX reserves that currently stand at approximately $3.125 trillion.5 But this could be about to change.
In March 2018, China launched yuan-denominated oil futures. This was widely seen as a move towards breaking king dollar's dominance of the oil market. If yuan oil trading volumes were sufficient, the futures would effectively create a new benchmark oil price in yuan, competing with the existing Brent and West Texas Intermediate (WTI) benchmarks. Oil producers hoping to export to China would want to track such a benchmark, so would be encouraged to price in yuan.6
The futures were extremely successful. On the first day of trading, 20 million barrels were traded; trading volumes over the next few days exceeded those for Brent crude.7 But, as a Forbes article notes, such futures contracts amount to little more than FX, not oil, trades because "Somewhere along the supply-chain someone will be paying in U.S. dollars" for the oil.8
A few days later, Reuters reported that China was planning to pay for oil imports in yuan, and that a pilot program could start as early as the second half of 2018, with purchases from Russia and Angola. Chinese "regulators have informally asked a handful of financial institutions to prepare for pricing China's oil imports in yuan," it said.9
But some are skeptical that China's moves will make much difference to the international pricing of oil in dollars, or thus to the king-dollar or the dollar exchange rate. Benn Steil and Benjamin Della Rocca, at the Council for Foreign Relations, point out that, "Oil exporters, especially, rely on U.S. Treasury markets to invest profits safely. This reliance in turn encourages many of them to peg their currencies to the dollar. Accepting non-dollar payment for oil thereby increases their foreign exchange risk."10
China's capital controls present another obstacle. Those capital controls make it difficult for exporters or other importers to use the yuan instead of the dollar because they restrict the international availability of the yuan and prevent it being freely traded on FX markets. Consequently, the yuan makes up only a tiny proportion of global FX. In April 2016, 88 percent of global FX transactions involved the dollar.11 And in December 2016, global king dollar reserves stood at $5 trillion, nearly half of total global FX reserves. In contrast, reserves in yuan were only $84 billion.12 The shortage of reserves makes it difficult for the yuan to substitute for the dollar in international trade. In the FX world, the dollar is very much king.
Russia and China have recently revealed plans to link their currency payment systems.13 This could make it easier for China to pay Russia in yuan for oil imports, bypassing global oil markets. But unless China further liberalizes its currency exchange rate and lifts capital controls, the emergence of a global oil market denominated in yuan seems a long way off.
Currently, the euro is the second-most used currency in international trade, and the second biggest reserve currency after the dollar. But it is still small by comparison with king dollar. In December 2016, euro reserves stood at $1.6 trillion, approximately one-tenth of international FX reserves: dollar reserves were five times the size.14 The Eurozone's prolonged economic slump seems to have caused use of the euro for international trade to decline: in April 2016, only 31 percent of FX transactions involved the euro, down from 33 percent in 2013 and 39 percent in 2010.15
However, there are signs of a possible "petroeuro" rise that could cause a swing away from king dollar and towards the euro.
Iran has had a euro-denominated oil market since 2005. Until recently, this was not seen as a major challenge to global pricing of oil in dollars. But in February 2016, Iran – the world's fifth-largest oil producer in that year – switched to demanding payment in euros for its oil exports.16,17
Perhaps more significantly, Iranian authorities have now announced that all financial reporting will be in euros. The reason given for this is that most of Iran's trade revenues are in euros, so reporting in euros makes sense.18 But it could also be to reduce exchange rate instability, since the Iranian rial has depreciated sharply versus the U.S. dollar.19
Russia has said that it wants to drop the dollar in oil transactions with Iran and Turkey, in favor of "national currencies."20 Russia's national currency is the ruble, but as global reserves of rubles are low, other countries may be unwilling to use it.21 However, Iran has already indicated a preference for the euro in oil transactions, while Turkey's strong ties to the European Union, together with the instability of its exchange rate,22 might also make the euro a logical alternative to the dollar. However, the composition of Russia's own reserves – king dollar rose to 46 percent at the end of 2017 compared with 40 percent a year earlier – don't suggest that it is seriously contemplating a move away from the dollar just yet.23
There are growing signs that some countries would like to see the end of king dollar. Moves to price oil in something other than dollars are a pointer in this direction. However, the Chinese yuan's claim to be the dollar's replacement is hampered by China's capital controls, while the euro is still a long way behind the dollar as an international reserve currency. King dollar’s crown – and the dollar exchange rate – appears secure for the foreseeable future.
With 17 years’ experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.
1. “The Future of the Dollar in the Middle East/Persian Gulf,” Momani; http://www.arts.uwaterloo.ca/~bmomani/Documents/NPE_GCC_Oil_Exporters.pdf
2. “How Petrodollars Affect the US Dollar,” Investopedia; https://www.investopedia.com/articles/forex/072915/how-petrodollars-affect-us-dollar.asp
3. “The Future of the Dollar in the Middle East/Persian Gulf,” Momani; http://www.arts.uwaterloo.ca/~bmomani/Documents/NPE_GCC_Oil_Exporters.pdf
4. “The Almighty Dollar: Is USD Dominance In The Oil Trade Waning As China Begins Using RMB For Payment?,” Forbes; https://www.forbes.com/sites/sarahsu/2018/04/05/the-almighty-dollar-is-us-dominance-in-the-oil-trade-waning-as-china-begins-using-rmb-for-payment/#6d8fb1a5bc87
5. “Forex reserves,” China State Administration of Foreign Exchange; http://www.safe.gov.cn/wps/portal/english/Data
6. “China launches oil futures to stake claim on its own benchmark,” Financial Times; https://www.ft.com/content/c73feed6-30b9-11e8-b5bf-23cb17fd1498
7. “China takes first steps in paying for crude imports in yuan,” Oil Price; https://oilprice.com/Geopolitics/International/China-Takes-First-Step-In-Paying-For-Crude-Imports-In-Yuan.html
8. “Why The Petro-Dollar Is A Myth, And The Petro-Yuan Mere Fantasy,” Forbes; https://www.forbes.com/sites/douglasbulloch/2018/04/26/the-petro-dollar-is-a-myth-the-petro-yuan-mere-fantasy/#a3a2b526a14b
9. “Exclusive: China taking first steps to pay for oil in yuan this year – sources,” Reuters; https://www.reuters.com/article/us-china-oil-yuan-exclusive/exclusive-china-taking-first-steps-to-pay-for-oil-in-yuan-this-year-sources-idUSKBN1H51FA
10. “China’s Currency Internationalization Is Failing: Oil Futures Won’t Save It,” Council for Foreign Relations; https://www.cfr.org/blog/chinas-currency-internationalization-failing-oil-futures-wont-rescue-it
11. “Triennial Central Bank Survey – FX turnover in April 2016,” Bank for International Settlements; https://www.bis.org/publ/rpfx16fx.pdf
12. “IMF Releases Data on the Currency Composition of International FX Reserves,” International Monetary Fund; http://www.imf.org/en/News/Articles/2017/03/31/pr17108-IMF-Releases-Data-on-the-Currency-Composition-of-Foreign-Exchange-Reserves
13. “Russia and China are talking about linking currencies to end the US dollar dominance,” Business Insider; http://uk.businessinsider.com/russia-and-china-discuss-linking-currencies-to-end-the-usd-dominance-2017-11
14. “IMF Releases Data on the Currency Composition of International FX Reserves,” International Monetary Fund; http://www.imf.org/en/News/Articles/2017/03/31/pr17108-IMF-Releases-Data-on-the-Currency-Composition-of-Foreign-Exchange-Reserves
15. “Triennial Central Bank Survey – FX turnover in April 2016,” Bank for International Settlements; https://www.bis.org/publ/rpfx16fx.pdf
16. “Exclusive: Iran wants Euro payment for new and outstanding oil sales,” Reuters; https://www.reuters.com/article/us-oil-iran-exclusive-idUSKCN0VE21S
17. “The World Factbook,” U.S. Central Intelligence Agency; https://www.cia.gov/library/publications/the-world-factbook/rankorder/2241rank.html
18. “Iran to replace US dollar with Euro in financial reporting,” Al Jazeera; https://www.aljazeera.com/news/middleeast/2018/04/iran-replace-dollar-euro-financial-reports-180418183855096.html
19. “Iranian rial hits all-time low as citizens scramble for US dollars,” The Guardian; https://www.theguardian.com/world/2018/apr/11/iranian-rial-all-time-low-us-dollars-tehran
20. “Russia Wants To Drop the Dollar For Oil Payments,” Oil Price; https://oilprice.com/Energy/Energy-General/Russia-Wants-To-Drop-Dollar-For-Oil-Payments.html
21. “IMF Releases Data on the Currency Composition of International FX Reserves,” International Monetary Fund; http://www.imf.org/en/News/Articles/2017/03/31/pr17108-IMF-Releases-Data-on-the-Currency-Composition-of-Foreign-Exchange-Reserves
22. “Turkish Lira Didn’t Get The Memo On Rate Hikes,” Bloomberg; https://www.bloomberg.com/view/articles/2018-06-04/turkey-s-lira-didn-t-get-the-memo-on-rate-hikes
23. “Putin Wants to ‘Break’ With the Dollar But Dumps Euros Instead,” Bloomberg; https://www.bloomberg.com/news/articles/2018-05-10/putin-wants-to-break-with-the-dollar-but-dumps-euros-instead