Reports of the end of the petrodollar are currently circulating (albeit not in the mainstream media). There are claims that a 50-year-old agreement between Saudi Arabia and the United States has not been renewed by Saudi Arabia. Although some are labelling this as fake news, if true, this poses an important question: what would the end of the petrodollar system mean for the global oil market?
The petrodollar, the foundation of the global oil economy for decades, not only reinforces the US dollar, but facilitates international trade and investment. The history of the petrodollar begins after World War Two with the Bretton Woods Agreement of 1944, which ensured that the US dollar, backed by gold, was the world’s primary reserve currency. This established fixed exchange rates between the dollar and other major world currencies. In 1971, President Richard Nixon terminated the convertibility of the dollar into gold, effectively ending the Bretton Woods Agreement and resulting in fluctuating exchange rates and concerns about the stability of the dollar. The Smithsonian Agreement of 1971which devalued the dollar in an attempt to salvage the Bretton Woods agreement combined with speculative market pressure in 1973 led to a catastrophic devaluation of the US dollar. To stabilise the dollar and ensure its dominance, a deal was allegedly made in 1974 with Saudi Arabia, the world’s then largest producer of oil, agreeing to price its oil exclusively in US dollars in exchange for military protection and economic assistance from the United States. However, whether the petrodollar arose through a formal agreement or simply evolved due to mutual benefit is still debated.
Despite the uncertain origins of the petrodollar, there are many definite benefits to the system for the US. Countries that need to buy oil from OPEC members must pay exclusively with US dollars, meaning that they must hold substantial reserves of the currency. This creates demand for US dollars and leads to large accumulations of US dollars by OPEC members that are often ‘recycled’ through investments in USassets such as stocks and Treasury securities. The constant global demand for US dollars ensures the strength of the dollar as the world’s primary reserve currency. In addition to the economic reinforcement brought by the petrodollar, there are geopolitical benefits to using crude oil export revenues denominated in US dollars. The alliances between the United States and key oil-producing countries forged through the petrodollar system aid in reducing the influence of rival powers such as China and Russia. Ensuring that oil is traded in dollars also assists in securing US energy supplies and stabilising global markets, which subsequently helps with economic security and growth.
The petrodollar system has also allowed for the US dollar and international monetary system to be used for political ends. As a result it has been under threat for some time, with some countries seeking to trade oil in other currencies, such as the euro or the yuan. Russia, Iran, and Venezuela account for about 40% of the world’s proven oil reserves, and the three countries have begun selling oil in yuan- denominated contracts in increasing volumes. The yuan’s role as a reserve currency may continue to strengthen, with its share of official holdings more than doubling since 2016. This is supported by China setting up mechanisms to enable yuan payments received for oil to be converted into gold. Increasing use of other currencies for oil trades challenges the dominance of the petrodollar and presents potential for a weakening global demand for US dollars resulting in US dollar inflation and rising US dollar interest rates. Although there may be a potentially disruptive transition period for global markets as the world transitions from US dollars as the primary currency for oil transactions, this may well prove to be a long, gradual process. This also has the potential to stimulate shifts in transatlantic relations and alliances.
But what are some of the legal implications of the end of the petrodollar system? It could have serious implications for existing production sharing agreements, tax/royalty concessions and service agreements. For example, mandatory work programme obligations are often expressed as a minimum US dollar spend in addition to a technical specification. There are also usually signature and production bonuses, declaration of commerciality bonuses, rentals per unit of surface area, domestic spending, training and other obligations, all often expressed to be payable as a fixed number of US dollars. If the US dollar materially depreciates these payments become less valuable to host governments and may even affect the viability of long-term oil projects. This could have deleterious effects on national budgets and fiscal deficits, economic stability and even result in political conflicts that stem from monetary distress. This is particularly relevant to developing countries where reliance on revenue from petroleum contracts represents a significant proportion of national income.
It is therefore quite possible that host governments, especially in developing economies may wish to renegotiate existing contractual terms. In these circumstances investors and governments will wish to closely examine the clauses in their agreements dealing with force majeure, stability, exchange controls, repatriation, tax, dispute resolution and the applicability of investment treaties. Of course, changes to production agreements are also likely to require lender consent and there may be consequent renegotiation of financing, joint venture and shareholder agreements. New agreements may require multi-currency options within these agreements and associated hedging agreements.
Regardless of whether the petrodollar system is coming to an end, developments in the market may have profound consequences on individual projects and countries and potentially affect regional and even global economic and political stability.
