The Dollar, the Euro and Oil

Includes: OIL, USO
by: James Picerno

The notion of pricing oil in something other than dollars has been around for some time. In fact, there's been a bull market in predicting just that, motivated in recent years by the buck's general descent in foreign exchange markets and the resulting financial pain the trend has imposed on foreign oil exporters and nations that buy crude with paper printed by entities other than the U.S. Treasury. But rarely, if ever (as far as I can tell), has any high-ranking OPEC official discussed the idea in public in direct and transparent terms. Until now.

On Friday, OPEC Secretary-General Abdullah al-Badri told The Middle East Economic Digest: "Maybe we can price the oil in the euro. It can be done, but it will take time," according to AFP. He also observed via The Guardian:

In oil exchanges in New York, Singapore or Dubai, you can see the currency is the euro or the yen. But as long as we see the final sign in dollar, that means the pricing is in dollars. It took two world wars and more than 50 years for the dollar to become the dominant currency. Now we are seeing another strong currency coming into the [marketplace], which is the euro.

Talking about pricing oil in something other than dollars is easy, of course. Doing it is something else entirely. The world's oil market is still firmly tied into pricing crude in dollars, and changing the financial infrastructure will, as al-Badri said, take time--years, perhaps decades. At the same time, no one should dismiss the growing incentive to tackle this task, and where there's a will there's a way.

Economic logic certainly suggests that an evolutionary process that allows more oil pricing in other currencies is virtually inevitable. The U.S. no longer dominates the world economy the way it did in 1960s, when OPEC was founded. That's less about America's decline than it is about the rise of developing economies and the birth of the euro. Competition, in other words, is on the rise, and so the no-brainer decision to price oil in dollars decades ago looks a heck of a lot less compelling in capitals beyond the U.S. shoreline.

Still, let's not go off the deep end. A large segment of the market in oil will probably always be priced in dollars for at least two reasons. One, the U.S. is the world's largest consumer of crude. And for obvious reasons, sellers of oil aren't eager to annoy their biggest customer with disruptive ideas about pricing. That's not to say that they won't engage in such actions, but they'll likely be on the margins and evolve slowly.

Two, the U.S., for all its troubles of late, real or perceived, remains the planet's biggest economy and the giant will remain a potent, if not dominant economic force for the remaining days of all who are reading this post.

Still, a rationale investor can't ignore the implications of euro-priced oil, however remote the odds look in the here and now. With that in mind, it seems reasonable to consider why China, Japan and other nations are so willing to hold dollars when the value of that paper has declined in terms of the home currency. One reason, although hardly the only reason, is oil. There's a certain economic logic to holding dollars if that's the medium of exchange for a strategic commodity that you routinely purchase. Then again, if it's possible to buy oil in some other currency, it's only reasonable to expect that such a shift will negatively impact demand for dollars. In turn, anyone paying for oil in dollars (hint, hint) will have to pay that much more for the commodity, and all other imports for that matter.

Clearly, the prospect that oil is destined to be priced in multiple currencies is bad news for the dollar, which has enjoyed something of a monopoly to date. At the same time, to the extent that this change is measured and evolutionary, the fallout in any given year should be minimal and perhaps even invisible to the man on the street. Also, oil is but one factor in establishing the dollar's international value. Nonetheless, the tectonic plates of the world economy are shifting and strategic-minded investors are well advised to pay attention and hedge themselves accordingly.