By Greg Lai and Alex Hsiao, Co-Chief Investment Officers
Strength of the Dollar Tied to Petrodollars
The petrodollar system is once again in the spotlight. In June 2024, headlines claimed that Saudi Arabia and the United States failed to renew a secret 50-year deal to keep pricing oil in dollars. The public has started fervently discussing the connection between the dollar and oil, posing new thoughts and challenges to the operation and significance of the petrodollar, together with concerns and anxieties about the dollar’s future stability.
However, various media outlets have debunked the existence of such an agreement. On June 13, The New Arab claimed that the news of Saudi Arabia abandoning the petrodollar agreement was purely a rumor. According to the report, such an oil agreement between Saudi Arabia and the U.S. never existed, “at least not officially.” Recently, neither the Saudi Press Agency nor the Saudi Gazette have mentioned anything about petrodollars or oil settlements.
Researchers have closely scrutinized the history of the alleged agreement dated in 1974. On June 6, 1974, then-U.S. President Nixon met with Saudi Arabia’s then Second Deputy Prime Minister, Prince Fahd, at the White House. Their meeting minutes, declassified in 2004, showed discussions focused on Middle Eastern political issues with no mention of petrodollars. On June 8, U.S. Secretary of State Kissinger and Prince Fahd signed a framework agreement establishing U.S.-Saudi economic and military cooperation committees. This agreement did not include a 50-year term or any mention of petrodollar arrangements. Following this agreement, Saudi Arabia continued accepting foreign currencies like the British pound for oil payments. As of now, the existence of a secret deal remains unverified.
Despite uncertainties about a specific petrodollar agreement, the system is real and crucial for maintaining the dollar’s international currency status. In the mid-1970s, after the collapse of the Bretton Woods system, the dollar was no longer convertible to gold and began depreciating. The U.S. forged strategic agreements with Saudi Arabia and other OPEC countries to stabilize the dollar and maintain its global dominance. These agreements didn’t explicitly mandate using dollars for oil transactions but created a system where oil-exporting nations could price oil in dollars, invest surplus dollars in U.S. Treasury bonds, and buy U.S. goods and services. In return, the U.S. provided military protection and market access, making the dollar the default currency for oil transactions and solidifying its role as the world’s reserve currency. This arrangement benefitted both the U.S. and oil-exporting countries by creating stable dollar demand and providing reliable investment tools for oil revenue. As a result, the dollar became somehow “linked” to oil. In the 1980s, with the introduction of oil futures products, the petrodollar gained more financial attributes, expanding into bonds, funds, derivatives, and official reserve assets, thus becoming more integrated with global financial markets. The petrodollar system helped the U.S. secure oil resources and established its dominance in the global energy and currency systems, contributing to dollar hegemony and significantly influencing global political and economic dynamics.
In recent years, with shifts in the geopolitical landscape, market diversification, and technological innovation, the proportion of global imports and exports denominated in dollars has begun to decline. Beyond the dollar, the yuan and euro are emerging as new currencies for oil trade pricing. In 2017, Saudi Arabia and China began negotiating oil pricing in yuan. In 2019, Russia’s Rosneft switched to euro settlements for new oil exports. Russian Deputy Prime Minister Alexander Novak stated that last year, about 40% of Russia’s oil and gas exports were settled in rubles, another 40% in yuan, and the remaining 20% in dollars, euros, and other currencies.
Despite many hints suggesting a subtle shift away from the exclusive use of the petrodollar system in oil trading, as of 2023, about 80% of global oil transactions still occurred in dollars. Whether an agreement exists between Saudi Arabia and the U.S. does not affect the strong relationship between the dollar and oil. Similarly, whether or not such an agreement (if it exists) is renewed must acknowledge that such a relationship is under close scrutiny by Economists, politicians, and the public. What finally matters is that “people are discussing this topic” itself. As noted at the beginning of this passage, this controversy has drawn public attention to the petrodollar system. In an era of intensifying power competition, the dominance of the petrodollar is continuously being challenged. Although new potential opportunities and the risks that come with them have already emerged, the petrodollar’s status remains strong for now. It seems it will take longer until it can be fundamentally shaken or threatened.
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