Prospects of the dollar as oil currency

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Moscow, (Igor Tomberg for RIA Novosti) - Oil prices and payments are vital for our country, a leader in the oil trade on a par with the Saudis.

The main headache is Russia's inability to influence world prices of its oil. The bulk of proceeds from trade in oil go to those who sell it to the end users rather than to producers such as Russian, Iraqi, or Iranian companies. It is the International Petroleum Exchange in London (IPE) and the New York Mercantile Exchange (NYMEX) which decide how much exported Russian Urals oil will cost. Moreover, their quotes are so far removed from the real cost of oil, and are influenced by so many speculations and other factors, that it is simply ridiculous to view them as a real indicator of price.

Currency is yet another feature of the oil trade. By tradition, prices are quoted in U.S. dollars. Any currency may be used for payments, but evaluation is always made in dollars. In this situation, both the sellers and the buyers prefer to deal in dollars in order to avoid extra transaction costs. It is this system of quotes and payments for oil (and the bulk of other major raw materials) that largely determines the status of the U.S. dollar as a reserve world currency.

However, a recent change in the alignment of forces in the oil market, accompanied by the U.S.'s huge budget and trade deficit and the growing importance of the Euro, has generated several attempts to revise the existing trade system. Moreover, these attempts have brought about serious changes in global politics. Some media outlets are convinced that the U.S. invaded Iraq in response to Saddam Hussein's demand that the oil-for-food program be converted to Euros instead of U.S. dollars. In September 2000 he declared that Iraq was no longer going to accept dollars for oil sales under the program and ordered the conversion of 10 billion dollars in the U.N. account into Euros. William Clark, a security expert and the author of research on oil currency problems, wrote that this choice had sealed Saddam's fate. He describes it as a "political move, but one that improved Iraq's recent earnings thanks to the rise in the value of the Euro against the dollar". This was the last argument in deciding whether to invade Iraq. When U.S. Marines invaded Baghdad, Iraqi oil started being sold for dollars again, he said.

This may not be the last war waged for the stability of the petrodollar. This year, Iran divulged a plan to open an oil trading exchange, which would operate in Euros rather than dollars. This plan caused serious concern in the oil community, primarily in the U.S. The proposed Iranian oil trading exchange has every reason to rival the IPE and NYMEX - more than a third of the country's oil exports go to Europe. Located close to major oil and gas importers, such as China, India, and Europe, Iran is a global oil supplier. It has 130 billion tons of proven oil reserves, or 10% of the world's total.

Latin American oil producers, such as Venezuela under Hugo Chavez[s1], would welcome the opportunity to sell oil for Euros. Gulf, Russian and Chinese oil companies also favor a switch to Euros. For the last three years, Tehran has been talking about being paid Euros for its oil exports to Asia and Europe.

Obviously, oil trade in Euros questions the status of the dollar as global reserve currency. But the idea that Iran's switch to Euros will ruin the dollar is preposterous because oil prices may be quoted in one currency while payments may be made in another.

Iran may be planning to open an exchange or bourse, but it will merely provide traders with indicative quotes, and the volume of sales moving through it will be very small. Moreover, any exchange mostly deals with contracts rather than real supplies. What may really influence the dollar's value, and the choice of reserve currency, is a massive switch to payments in a different currency by real buyers and sellers. The start of a Euro-denominated exchange will not by itself affect the dollar. As for the Iraqi case mentioned above, it could well have meant payments in Euros for a considerable amount of oil. This could have undermined the petrodollar monopoly and created an unwanted precedent for the U.S.

For the time being, the dollar as oil currency is not under any tangible threat.

From 60% to 70% of the world's exports and about 60% of global currency reserves rely on the dollar, as well as 80% of all currency transactions and 70% of all bank credits. Leading Russian financial experts are so far skeptical about the dumping of the U.S. dollar as oil currency.

Former head of the Central Bank Viktor Gerashchenko, who now chairs the Yukos Board of Directors, said: "If you trade in oil, stick to the dollar. I believe that in the next ten years nobody will quote oil in Euros, rubles, yuan, or anything else. The price is going to be set in dollars no matter what, especially considering the size of the U.S. economy. Only China may catch up."

Head of the Federal Financial Markets Service Oleg Vyugin attributes this to objective factors. "Oil prices are quoted in dollars, not Euros. For this reason, any oil-sales contract will refer to the dollar quotes of the oil markets, even if the sale is concluded in Euros... If oil prices start being quoted in Euros on a big, liquid market, Euro contracts are bound to be signed," he said.

Russian experts have long been talking about the need to create an environment in which Russia could influence world oil prices. This task is becoming an even bigger priority in the context of global changes in the world currency and financial markets. The reform of the world financial institutions - the IMF and the IBRD - will soon be completed. Many analysts describe it as a reform of the Bretton Woods system of monetary management that will concentrate on streamlining the system of oil price formation.

Recently, the problem of Russia's role in fixing oil prices has enjoyed the support of its authorities as part of a more ambitious program to make the ruble fully convertible. In his address to the Federal Assembly on April 25, Russian President Vladimir Putin suggested that major Russian exports, such as oil and gas, should be traded domestically for rubles under the program. The aim of his proposal was to encourage the main consumers of Russian energy to stockpile rubles for purchasing commodities on domestic trading lots. This would create global demand for the Russian currency, and the ruble would be used abroad, just as dollars and Euros are now spent by Russia on importing goods and services.

The implementation of Putin's proposal is bound to enhance the status of the ruble in the world, but directives do not work in a market economy. London and New York have traditionally been the centers of trade in hydrocarbons. The attempts by Iraq and Iran (and perhaps, in the future, Venezuela) to quote crude oil prices in Euros have not changed the supply-and-demand balance in the market, nor made them centers of world trade or price formulation. As before, dollars are used to quote oil prices, which in turn depend on WTI and Brent crude prices.

At the same time, Russia's desire to join the club of reformers points to a steady trend towards revising the current system of quotes and payments on the oil market. The dollar monopoly no longer seems unassailable. If oil starts to be traded in other currencies, the dollar's dominance will end.

Igor Tomberg, Ph.D. (Econ.), is a leading researcher at the Center for Energy Studies at the Institute of World Economy and International Relations, Russian Academy of Sciences.

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