Revival of the Petrodollar Recycling Machine

Generally we think of the Federal Reserve as being very queasy, in an old school sort of way, about rising oil prices. But at a time of collapsed trade flows and the attendant reduction in Dollar reserve building, might the Fed secretly welcome an advance in the price of oil? Readers of this site know that in a number of posts this year I’ve laid out the case that recession is bullish for sovereign debt, but collapse is not. In addition, at a time of 1.5 -2.0 Trillion dollar annual budget deficits in the US, I’ve also noted the punk rate of saving here domestically that cannot hope to cover such spending increases. And so, into this gaping maw the Fed itself has been active, buying 300 Billion of Treasury debt so far in 2009. But with the rise in the price of oil, have oil producer recycling flows started back up again?

click to enlarge

The price of oil melted down starting 15 months ago, and dug itself a hole right into the most acute phase of the global industrial slump. You will recall of course the idle ships, stalled rail freight and dead trucking that accompanied the lows in global trade, during Q4 2008 and Q1 2009. Those spectacular falls would have been made all the worse, however, by the price crash in the world’s number one most important commodity. For example, according to the EIA, OPEC alone earned nearly a trillion dollars in net export revenues in 2008, a 42% rise on the previous year 2007. Consider also that OPEC oil generally accounts for only 40% of total global oil production. So you can see how a swing in the price of dollar-denominated oil would form a not insignificant part of total world trade.

Yes, oil revenues are down big in 2009 compared to 2008 for all oil producers. But given that oil spent at least four months in Winter around an average price of 40 dollars, it stands to reason the six month recovery to 80 dollars coming out of March has been quite beneficial to dollar flows, and dollar liquidity. And so I have to ask: have the large oil producers returned (at least to the short end of the US Treasury market), snapping up issuance like yesterday’s auction of two year notes?

At the current rate of global oil production around 72 mbpd (million barrels per day) the gross dollar revenue difference annually between 40 dollar oil and 80 dollar oil comes in at around 1 Trillion dollars. Again, that is just a gross dollar value of production and a good portion of that is not directly recycled via oil exports. But it gives some sense of how just a 40 dollar swing in the price of the master commodity can impact global liquidity. While I will leave for another time the myriad issues that surround the distortions of this capital build up in oil producers, and the self-destructive effects this has on big importers like the United States (which continues to have no energy policy), it does seem fair to conjecture that the rise in oil prices is helping the US Treasury. The next time you hear the Fed Chairman, who is currently running a low interest rate operation, comment publicly on the price of oil, it might behoove you to consider that the petrodollar recycling machine is very much back in play.

Comments

[Ferdinand E...:]

Interesting, but I wonder if it is going to be the same thing this time as before. As far as I can tell, the big oil exporters are more interested in buying PHYSICAL assets than they were a couple of decades ago. I'm not certain, but I think that they were informed that they could not purchase every mountain in Switzerland. Now - thanks to globalism and internationalism - they can buy anything they want.

Oct 28 09:23 AM

[goldbug101:]

Perhaps the recent oscillation of oil prices is the new “norm” and that is the default energy policy of the US.

Prices rise – Treasury sales are simply marvelous at low interest rates.

High oil prices ($150 -$200 bbl) cause worldwide disruptions and the crash seen last fall/early this year repeats.

Prices fall – USD (relatively) soars as the worldwide economy’s tide goes out again.

Wash, rinse, repeat

Oct 28 10:37 AM

[Mad Hedge F...:]

pue ) Will people pleeease stop incessantly nattering about the possibility of China dropping the dollar as a reserve currency? What else are they going to use? Monopoly money? Taiwanese dollars? Collectable postage stamps? At $2.3 trillion and rising fast, the Middle Kingdom’s reserves are so enormous that no other currency in the world could accommodate the switch, and no other security offers the necessary depth and liquidity but US Treasuries. China only needs to breathe on any other market for it to skyrocket, we have seen in the relatively Lilliputian commodity markets this year. And really, how likely is it that China embarks on radical new monetary policies that suddenly halves the earnings of it’s exporters, as well as its 30 year hoard of accumulated savings? The demise of the dollar has been predicted more often than the ditching of Microsoft’s Windows as the global PC operating system, and is just as likely. Hate the greenback as much as you like, but there just isn’t any other alternative. I have been hearing these arguments ever since the US went off the gold standard in 1973. First there was a perennial Arab threat to price crude in a basket of currencies. Gee, they never seem to complain when the buck is going up. Then there was the speculated emergence of the “Yen Block”, in the eighties, back when Japan was dominating international trade and the yen was bumping up against ¥80 to the dollar. Remember the book “Japan as Number One? What a laugh. Then we got all that European whining after the launch of the euro, when the weak dollar was every trader’s free lunch. Let’s face it, Europeans hate using someone else’s currency as the primary reserve instrument. Before the dollar, sterling was the de facto reserve currency, and was equally despised. So rather than waste time discussing this issue anymore, let’s talk about something more important, like who is going to win the World Series this year. I’m wearing my Yankees hat.

Oct 28 12:16 PM

[jerrydd:]

Goldbug is right. Until we have a get off oil policy, we will be in recession again and again.

We need to tax it to drop production which will cause most of the tax be paid by Iran, Russia, oil dictators from lower oil prices or we will be broke, at war, in recession thanks to repubs and a few oil, coal state dems.

Oct 28 12:23 PM

[Living4Divi...:]

Interesting theory

Are you saying that Oil Prices serve as a support for the USD ?

Oil is priced in Dollars, but has a real value, independent of Dollars.
If one day, the Dollar drops 25%, then the price of oil rises by 25%.
Petroleum exporting countries then recycle their extra 25% back into Dollars and this gives some support to the USD. MAkes sense.

Is that the crux of the theory?

Oct 28 12:53 PM

[Living4Divi...:]

Just curious if
a) that is the crux s the author's argument ...and...
b) If others agree with the author's argument

Curious to hear what others have to think

Oct 28 12:55 PM

[derryl:]

I think Gregor's point is more that oil exporters need somewhere to put all those US dollars they're collecting and Treasuries offer a big enough bin to receive them. This additional demand for dollar denominated investments would help support Treasury prices and hold down yield, but it does not create any additional demand for dollars themselves so it would not support dollar's fx value. On the other hand by offering a place to absorb the excess supply of dollars, Treasuries' dollar absorption may help prevent further declines of the dollar that would result from all those oil payment dollars being spent into the world.

Oct 28 04:45 PM

[SeekingTruth:]

Another clue as to why we have no energy policy (even after 35+ years to develop one), and probably why we will never get one when this is added to a lot of other things.
We the people continue to be dragged behind the pickup truck driven by the powers that be that find it all too easy to siphon off their large "management fees" and stealth money laundering advantages.
If anyone has any suggestions, please speak up, because things are getting really depressing.

Oct 28 05:56 PM

[manya05:]

Let me postulate a possible reason why we do not have an energy policy. The entire US economy and lifestyle is predicated on the ability of moving people around in cars and go, as individuals, from point A to point B at any time you want. In other words, the functionality of cars and highways is built into the US economy. We just do not have the means to survive as a viable nation without that (not feasible to redraw every city and collapse them to a dense core, not possible to build viable mass transit systems with the low density we have). The most efficient way of moving people from point A to pint B at will is by cars, powered by internal combustion engines, that run on oil. You can play all you want with new technologies, but you will never get to the energy density of gasoline (oil) for transportation application, and every step you add (electricity, synthetic fuels, you name it), is adding inefficiencies (cost) to the picture. So I suspect we do not have an energy policy because having one is equivalent to having to tell people that the functionality that we now have will have to go away (lifestyle change). This is just not a popular position for the government to take. Thus, the inaction that we have witnessed over the last 35 years (we are talking a generation here).

Oct 28 07:30 PM

[EUARTE:]

Yes, I do. It is corruption. The Saudi's have bought all the envoys to The Kingdom. Do some research. Look at the employment and sudden wealth of our ex-envoys.


On Oct 28 05:56 PM SeekingTruth wrote:

> Another clue as to why we have no energy policy (even after 35+ years
> to develop one), and probably why we will never get one when this
> is added to a lot of other things.
> We the people continue to be dragged behind the pickup truck driven
> by the powers that be that find it all too easy to siphon off their
> large "management fees" and stealth money laundering advantages.
>
> If anyone has any suggestions, please speak up, because things are
> getting really depressing.

Oct 29 11:10 AM

[SeekingTruth:]

EUARTE: I have no doubt that you are correct, which means that the envoys are "double dippers" , being bought off by both sides of the trade.

The Saudi Royal Family are the true rulers of the world. Frontline proved this to my satisfaction.

Oct 29 09:46 PM