Kuwait Times

Published Date: December 19, 2007
By Rania El Gamal, Staff Writer

KUWAIT: Could oil producing countries drop the dollar for a more stable currency? Iran's recent announcement that it would stop using the dollar in its oil transactions made that question a plausible scenario for other oil producers to follow with a weakening US economy and a declining dollar. The depreciating US currency worries oil exporting countries as it means a reduction in the value of their dollar reserves and a loss in revenues with the spiraling oil prices. So could Iran's decision signal a tren
d for other oil producing countries to follow?

Iran, the world's fourth largest oil exporter, is urging other members in the Organization of the Petroleum Exporting Countries (OPEC) to also drop the greenback as it is too unreliable. The oil-rich country, argued last month at the OPEC oil ministers meeting, that oil producers are losing revenues because the dollar is performing poorly against the euro. Tehran is pushing OPEC to drop pricing oil in dollars and shift to a basket of currencies, though Saudi Arabia clearly is opposing the notion. Saudi fo
reign minister warned that talking publicly about the dollar's decline could hurt its value even further.

Iran receives non-dollar currencies for 85 percent of its oil products and is already asking its customers to pay in euro or yen. Recently, the Islamic Republic requested that its shipments to Japan be traded for yen instead of dollars. On December 8, Iran's oil minister said that the major crude producer has completely stopped carrying out its oil transactions in dollar.
As OPEC controls only 40 percent of world's oil production, is it possible for other non-OPEC countries to follow Iran's suit and drop the dollar from its oil deals?

Yes, other oil producing countries can always follow Iran and drop the dollar from oil deals - Iraq had done this before the US invasion. Venezuela has talked about this possibility for some time. Russia has also considered such a move," Professor Robert Looney of the National Security Affairs Department at the Naval Postgraduate School in California, told Kuwait Times via email. "On the other hand, there are no clear benefits in doing this - certainly in the short run. Dollars can be easily converted
into other currencies and investments made where the rate of return is highest," he added.

OIL DOMINATES
David E Kirsch, Manager, Market Intelligence Service, PFC Energy says that though oil producers can denominate their oil in any currency of their choosing, dollar still dominates the global oil market.

In addition to Iran's insistence on payment in euros or yen, there are also anecdotal reports of other producers allowing payment in euros as well. This is accomplished, however, through a relatively mechanistic means, by establishing a certain index to calculate exchange rates in a similar fashion to the calculation of actual oil prices in reference to a marker crude," said Kirsch. "The global oil market remains a dollar-denominated one, and the acceptance not only by oil producers and refiners of the m
ain US-dollar denominated contracts - especially WTI and Brent - but also the financial community acceptance of these contracts that keeps oil dollar-denominated," he added.

Currently, crude oil sold is based on three official benchmarks: West Texas Intermediate in the US traded on the NYMEX; Brent traded on the ICE in London; and the Middle East Dubai/Oman crudes as assessed by Platts or settled on the Dubai Mercantile Exchange. All are priced in dollars.

What governs oil deals to be priced in dollars?
The pricing of oil in dollars is not a formal agreement, but instead a practice that began years ago. The oil exchanges are in dollars and thus the market price so it makes sense to keep the whole chain of oil prices in that currency," said Looney. "This is one reason the Iranians have from time to time considered establishing an oil bourse denominated in euros. At this time the conversion of oil pricing from dollars to euros would be very time-consuming and again hardly worth the effort.

Iran has plans to create the Iran Oil Bourse, an open commodity exchange. If established, the exchange would make it possible to trade oil and gas in non-dollar currencies, such as the euro.

In Iran's case, US pressure to end financial transactions with Iranian banks to perform U-turn transactions involving US currencies necessitated a need to shift currencies," Kirsch said.

Tehran is not alone in its desire to establish an alternative to trading oil in dollars. In 2006, Russian President Vladmir Putin expressed interest in establishing a Russian stock exchange which would allow "oil, gas, and other goods to be paid for in Roubles." The Russian parliament has previously discussed adopting the euro for oil deals.

Venezuela, another country with an antagonistic relationship with the US, also holds little loyalty to the currency. The country chose to establish barter deals for oil, which allow Venezuela to trade oil with 12 Latin American countries and Cuba without using the dollar. In September, the country's president Hugo Chavez instructed state oil company Petroleos de Venezuela SA to change its dollar investments to euros and other currencies.

BREAKING DOLLAR ALLIANCE
But Saudi Arabia, the world's largest oil producer, is against changing the oil pricing regime or even publicly discussing the move.

Last month, on the eve of the OPEC meeting, Saudi Foreign Minister Prince Saud Al-Faisal said dropping the dollar from oil transactions is "a sensitive issue". "It will cause the dollar to drop further, thus complicating the problems we are facing from the dollar's fall," he said.

The Saudis have $20,000 billion in oil reserves and $800 billion in US dollar reserves. The whole Gulf countries have $3.5 trillion under management. Dropping the dollar as a reserve currency and changing the oil pricing regime would mean huge financial losses for the Gulf countries, and a big blow to the value of the dollar.

Still the United States is not the main oil importer for all the Gulf countries. For instance, Kuwait exports the majority of its oil (more than 60 percent) to Asian countries such as Japan, India, Singapore, South Korea, and Taiwan. So is it a far-fetched thought that Kuwait, also can ask its Asian customers to pay another currency other than the greenback?

For Kuwait and other oil producers to follow Iran's suit, the rationale is not as clear, says Kirsch.

Certainly a depreciating dollar and expansionary monetary policy is creating problems for Gulf countries -especially those that unlike Kuwait have not adjusted their currency pegs. But most of the necessary adjustments can be made by changing the composition of reserves held," he said. "Thus whether the revenues are received in dollars and converted by the central bank, or in euros is less material at the end of the day, removing much of the urgency in shifting the basis of oil transactions from the dol
lar," he added.

Looney echoes the same concept. "At the present time, I cannot see another Gulf country pricing oil in currencies other than the dollar. For one thing, most of these countries hold large dollar reserves. A move of this sort would create uncertainty about the dollar, thus forcing its value down even further. The resulting loss in the value of reserves would not really be worth any benefits obtained from non-dollar oil pricing," he said.

The Gulf countries, with the exception of Kuwait, peg their currencies to the US dollar. In May, Kuwait broke its dollar peg and shifted to a basket of currencies. Though Kuwait has not disclosed the composition of its basket, but it is believed to be 70 percent dollar-based with the rest in euro, yen and sterling pound.

NON-DOLLAR MARKER
The real question is not whether other oil producers will take payment in euros, but whether or not a new marker can be established in a non-dollar currency?"wonders Kirsch.

The risks in this regard are quite sizeable, as this entails finding essentially a new marker contract that would be acceptable to both paper and physical traders. As the experience with the Dubai Mercantile Exchange demonstrates, establishing a new marker contract with sufficient liquidity is no simple task, even when there is a compelling market rationale for such a contract," noted Kirsch. "Even with current dollar weakness, I do not think we have a clearly compelling case that a new marker currency
must be found, taking away some of the momentum for establishing new financial architecture for global oil markets," he added.

But the composition of official foreign exchange reserves and the currency or basket of currencies on which countries peg their currencies are two separate issues, says Looney.

As you know Kuwait now pegs its currency to a basket with the dollar, euro, pound and yen as the main currencies. This reflects Kuwait's changing trade patterns and makes good economic sense. By doing this there would be little to gain by moving further and actually pricing oil to one of these currencies," he said.

Many countries already are diversifying their foreign exchange reserves with the weakening US dollar. Last month, China, the world's largest holder of US dollar, has signaled plans to diversify its $1.43 trillion of foreign exchange reserves into more stronger currencies.

To a large extent, this shift in holdings-not just by central banks, but especially the portfolio assets of sovereign wealth funds-is already happening as a reflection of the changing value of the dollar, and based largely on commercial considerations," said Kirsch.

GLOBAL ECONOMY
Yet if shifting away from the dollar oil pricing regime happened, how will it affect the global economy?

If Kuwait or other Gulf countries required payments other than the dollar for oil, the effect would be mostly psychological," said Looney.

He explained that the so-called "dollar zone" would be shrinking and many would feel that the dollar would be going through a long period of decline as other countries followed suit. The dollar would fall in value and many countries would take great losses in the decline of the value of their official reserves.

It would create added uncertainty for the world economy and perhaps increased instability in foreign exchange markets. Exports from the US would begin to penetrate the EU, perhaps causing trade wars between the two - one can think of a number of possible scenarios, but there are too many degrees of freedom to point to any clear path the world economy might take," said Looney.

Currencies go through cycles. The dollar is down right now, but once it begins to recover and the euro fall, most of the talk of non-dollar oil pricing will quickly disappear.