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June 2008 - Analysis – Energy finance	<< Issue Index
RSS Feeds Opec and the dollar If Opec pulled the plug on the dollar, the financial turbulence of the last year could be eclipsed by even greater problems. That is one of several reasons why the cartel will not take the step, writes Derek Brower YOU OWN the world’s most valuable commodity. And when you sell it, the buyer gives you a piece of paper whose value has been plummeting for months. In these terms, it is not hard to see why Opec members wince when they talk about the persistent weakening of the dollar. They sell oil, they receive dollars in exchange and when they come to use them – to buy food, luxury goods, weapons and whatever else they need to import – they find that the currency is now worth a little less than it was when they sold the oil. The erosion of the oil producers’ purchasing power is part of a cycle that is, to a large extent, out of their hands. As the US economy has spluttered, the Federal Reserve has cut interest rates in an effort to rescue it from full-blown recession. As lower interest rates make the dollar less attractive compared with other currencies, such as the euro, in countries where interest rates are higher, the dollar-denominated price of oil rises to compensate. And, as oil prices rise, the threat of recession in the world’s biggest consumer countries – and especially the US – becomes greater again. It is not quite that simple: there are other reasons for the oil-price rise, not least the apparently unquenchable appetite for crude in the booming economies of Asia – inflated in many countries by generous state subsidies on refined products – and the industry’s failure to keep supply growing as quickly as demand. But the dollar is, nonetheless, under threat. Worthless paper The issue came to a head at an Opec meeting in Riyadh in November, when Venezuela and Iran both called for the group to abandon the dollar and price its oil either in euros, against which the dollar’s fall has been stark, or a basket of currencies. “They get our oil and give us a worthless piece of paper,” Iran’s President Mahmoud Ahmadinejad said then. Hugo Chávez, Venezuela’s president, agreed. In February, Iran’s long-awaited oil bourse opened on Kish Island, trading oil and products in euros and Iranian rials. The opening of the bourse passed largely unnoticed – and failed to trigger the collapse in the dollar predicted by some analysts. But elsewhere among the Opec nations, the momentum for a wider switch away from the dollar has grown. “Maybe we can price the oil in the euro,” Abdulla El-Badri, the group’s secretary-general, said in February. “It can be done, but it will take time.” As a symbol of US power in the world, the pre-eminence of the dollar takes some beating. That is why its recent decline has also been heralded by some, gleefully, as a signal of the “empire’s” decline. “With the fall of the dollar, the deviant US imperialism will fall as soon as possible too,” Chávez said in November. But other similar voices do not just come from the US’ enemies in Tehran and Caracas. Ron Paul, a senator from Texas who ran for the Republican nomination in this year’s US electoral campaign, has long claimed that his country’s wars in the Middle East are as much about defending the dollar as they are about oil. “Using force to compel people to accept money without real value can only work in the short run,” he said in a statement to the House of Representatives in 2006. “It ultimately leads to economic dislocation, both domestic and international, and always ends with a price to be paid.” Everyone stands to lose But it would not just be the US that pays. China’s foreign-currency reserves stand at almost $1.5 trillion, according to the CIA; Japan’s at almost $0.9 trillion; and Russia’s at almost $0.5 trillion. Over 60% of global reserves are in dollars. If Opec suddenly demanded euros instead of dollars for its oil, the plunge in the currency’s value would hardly be welcomed in the capitals where the reserves are concentrated. If China sold its dollars, the currency would collapse – but so would China’s ability to export goods to the US. Nor would such a move be welcome in the euro-zone, where pricier euros would hit exports and wipe out any benefit the zone accrues by buying energy in dollars. But perhaps most significant are the $4 trillion of dollar reserves held by the Mideast Gulf states themselves, suggests Stephen Schork, editor of the Schork Report, a newsletter about oil prices. Aside from Iran, the Gulf’s Opec members would be unlikely to devalue their currency reserves overnight. Iran and Venezuela may take economic decisions for reasons connected to their opposition to the US, says Schork, but Opec’s other members do not. Saudi Arabia, for one, quickly dismissed the currency shift idea in November. Other producers around the world would also take a hit from such a switch, given that consumers are transferring some $1.8 trillion a year to oil exporters, according to investment bank Goldman Sachs. And there are other fundamental reasons why such a switch would not work. Despite the Iranian bourse and the efforts of Dubai to become a regional trading hub for commodities, Opec has no real ability to set the price, says Manouchehr Takin, an analyst at the Centre for Global Energy Studies. “They follow what happens in New York and London.” It may be in the interests of Opec’s Gulf states to develop a benchmark to rival Brent or WTI, but the varying qualities of the crudes sold from the region would make that difficult, he says. And it would be just as hard to unravel an entire trading complex that is based on dollars. And until that happens, prices for the world’s oil markets will be decided by traders in the US and UK. Schork agrees, pointing out that the volume of screen trading in futures on ICE and Nymex – all in dollars – is at least as big as the trading in physical oil elsewhere. Practical solutions More practical solutions for the producers exist than abandoning the dollar. The dollar pegs in the Gulf could be adjusted to increase the value of local currencies – and their purchasing power. Indeed, the currency markets price futures for local Gulf currencies much higher than the price at which they trade now, suggesting traders believe an adjustment will happen. Kuwait dropped its dollar peg for the dinar last year and the currency remains the highest valued in the world: one dinar buys almost four dollars. For some economists, the debate is irrelevant anyway. “My instinct is that the effect would not be as large as many commentators fear,” says Andrew Oswald, professor of economics at the University of Warwick. “There would be some short-term turbulence in the currency markets. But ultimately economics tells us that it does not matter whether I buy something by paying Australian dollars for it, or yen, or euros. These differences eventually come out in the wash.” In other words, the market would adjust to whichever piece of paper became its reserve currency. While the producers ponder whether to wait for the wash, consumers in the world’s biggest oil importer could find some relief soon, say analysts. The implicit weak-dollar policy of the President George Bush’s White House will probably end with a new administration. The policy has boosted exports, but the advantages of an improving trade balance have been lost amid rising oil prices – a consequence of the dollar’s fall.
Source: Petroleum Economist