Dollar-Oil Link Soon to Be Broken?


Dollar-Oil Link Soon to Be Broken?

Saudi Arabia is pursuing new oil trade opportunities at America’s expense.

CYPRUS—New York may be about to lose its status as the world’s biggest oil-trading center. Saudi Arabia is leading the exodus. How will this shift impact America, and what are the implications for the dollar?

Saudi Arabia is a Persian Gulf Arab state, awash in vast amounts of oil, with high levels of oil production and massive oil reserves yet under its desert sands—that is the popular wisdom. However, the truth may be completely different.

Within this context, the Saudis are exploring opportunities to sell their oil on more transparent exchanges in which they feel they have some logical control over production levels and pricing in relation to world demand, and opportunities to be paid in currencies besides the anemic U.S. dollar. Such a move would be a great influence on all of the Organization of Petroleum Exporting Countries. This has crucial implications for the United States, as it could siphon oil trading from U.S. exchanges and eventually flush out the dollar as the currency of trade.

Saudi Arabia has generally had falling oil production since its all-time peak in 1980 of 9.9 million barrels per day. Present Saudi production is estimated to be around 9 million barrels per day. The big question: Is declining Saudi production due to the fact that the desert kingdom is running out of oil, or is it a voluntary action to reserve oil for potential higher prices in the future?

Saudi Arabia exports 7 million barrels per day, about 9 percent of the world’s 75 million barrels of crude oil consumption.

Some oil experts (like Matt Simmons) believe that Saudi Arabia is now beyond peak oil production, or very soon will be. The low-quality crude oil (sour and heavy) coming out of Saudi Arabia would also suggest that its oil fields are approaching exhaustion.

In this context, the Saudis are now attempting to break loose from the way their oil is priced, which is linked to Western institutions’ mechanisms (including West Texas Intermediate, and the New York Mercantile Exchange).

The Saudis, along with a growing number of countries and oil sector insiders, are weary of the dominance of Western institutions like wti and nymex. These exchanges are heavily influenced by speculation in their pricing.

In recent times, some voices have suggested that the July 2008 spike in oil prices to $147 a barrel was partly due to speculation, and the deep positioning of speculators in derivative funds. The intense speculation, along with increasing demand from developing economies (China and India), pushed oil to a new all-time record. The opaque vagaries of these Western mechanisms are unpredictable and not as subject to the market forces of supply and demand as they should be.

Saudi Arabia is now attempting to withdraw association with these mechanisms and possibly align its oil sale and pricing with exchanges like the Dubai Mercantile Exchange, which reflects the market realities of supply and demand better than the Western exchanges and all their massive speculation and derivatives.

The reason for this Saudi move probably is twofold: 1) to keep oil prices on a generally higher level and 2) to keep oil prices more stable and predictable. Thus the Saudis will feel some level of logical control over aligning their production with world demand, and in so doing more definitively set prices based on market forces.

The anti-Western mood in many areas of economy and politics is palpable. So this move with the Saudis will most probably result in the weakening of these Anglo-Saxon commodity exchanges. Surely Venezuela, Iran and Iraq would be candidates to follow suit. But a string of other oil-producing nations, like other Persian Gulf states (Kuwait and Abu Dhabi), African oil-producing countries, and eventually Eurasian Russia, could get aboard the Saudi move when they see alternative exchanges give more realistic, predictable and stable prices—and drain power from the West. Even further, the Saudis have massive influence in opec, so the way the Saudis decide to sell oil on the world market would indicate the route opec would be expected to follow.

In early November, the Saudis took the step and adopted the London-based Argus U.S. Sour Crude Index. Since then, major oil exporters in Latin America and the Middle East have expressed strong interest in switching the basis of their oil prices to Argus.

The Saudi move is an attempt to realign the world oil market from frustration with wti, and so it is expected that many other sour crude exporters will follow the Saudi move. The wti could become increasingly irrelevant in world oil trade.

Khalid al-Falih, the chief executive officer of Saudi Aramco, the Saudi National Oil Company, said that “The Argus index was a solution … we believe it is good for our customers, it’s good for us, it’s transparent and will solve the problems that we will see in the future” of aligning price with current market forces.

Of course, bypassing the increasingly despised and emaciated American dollar also is an advantage of fleeing the American exchanges. A more stable currency would be desired to trade in oil, and that just could be the rising “new boy on the block”—the euro.

Saudi Arabia may be followed by many other countries, and this may mean that the United States will watch international trade trend toward sidelining America. U.S. prestige and influence could become incidental. Eventually, the U.S. may not be able to easily buy on international markets (as the dollar becomes unacceptable), so commodities like oil could become unobtainable. With two thirds of oil consumed in the U.S. being imported, imagine what the dramatic effects would be.

Saudi Arabia, which is probably in declining oil production, wants to control its oil selling price as best it can, getting the highest realistic prices possible in the last decade of its status as an oil-exporting nation. It has decided that a more transparent and less-speculated exchange is the solution. As other nations follow, U.S. economic and political prestige will get hit as hard as its once-mighty dollar. Future implications are dramatic, as Americans eventually may not be able to find sources to import oil and its many spinoff products, unless payment is made outside the dollar.