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Since the early 1970s, most major oil deals have been transacted in “petrodollars.”
But that system has become increasingly challenged in recent years.
The conflict in Ukraine right now has only served to exacerbate things.
As America leads the charge to impose Western sanctions on Russia, it’s a plan that’s not only backfiring, but leading to opportunities for those who understand the consequences…
The Waning Petrodollar
After Nixon infamously closed the gold window in 1971, something needed to be done to retain the U.S. dollar’s status as world reserve currency.
So Kissinger and Nixon hatched the petrodollar system, whereby the United States would provide political and security support to Saudi Arabia’s royal family.
In exchange, all oil deals would have to be transacted exclusively in dollars, so the House of Saud would buy lots of Treasuries with their greenbacks and influence other OPEC members to follow suit.
In effect, this guaranteed a constant and elevated (though artificial) demand for U.S. dollars worldwide.
But this fabricated demand is waning as trading nations question the need for a petrodollar, and even the U.S. dollar as a reserve currency.
The Impact of Playing Russian Roulette
Since Russia’s recent seizure of Crimea, the West has imposed a number of sanctions on Russians from Putin’s inner circle, such as asset freezes and travel bans.
In late March, both Visa and MasterCard temporarily suspended service with seven Russian banks without warning, since their controlling shareholders were being sanctioned.
That prompted Putin to say Russia should create its own national card payment system, much like China and Japan did years ago.
Then roughly a week later, JPMorgan blocked a payment from a Russian embassy in Kazakhstan to an affiliate of a U.S.-sanctioned bank, Sogaz Insurance Group. It was for a measly $5,000, but that was enough to make sparks fly.
An infuriated Russian foreign ministry called the decision “illegal and absurd.” The next day, JPMorgan agreed to process the payment.
Inevitably, these tactics have left Russia with a bad taste, and increasingly exploring its options.
Russia’s Reading China’s Playbook
Feeling uncomfortably vulnerable from these and other aggressive financial sanctions, Russia has begun looking to its Southern neighbor, China, for alternative trade routes.
Already Rosneft, Russia’s largest oil company, has recently inked a number of large oil contracts for export to China, and apparently a “mega-deal” is nearing completion with Indian firms.
What’s notable here is that, in both cases, not a single U.S. dollar will change hands.
But Russia’s circumventing the petrodollar won’t end there.
Since January Iran has been discussing the possibility of a barter deal, with Rosneft taking up to 500,000 barrels/day of Iranian oil to sell into world markets. In return, Russia would provide Iran with a number of Russian goods that it needs.
This kind of trade deal is being explored due to sanctions against Iran over its nuclear program. It could be worth an extra $1.5 billion per month for Tehran, once again outside the petrodollar.
Back in January, I told you how China was sidestepping the U.S. dollar. In The Golden Yuan Is Coming – Here’s How to Play It, I spoke of how China has been establishing currency swaps with other countries to settle trade. They now have as many as 25 such swap agreements in place with various nations, estimated to be worth nearly $1 trillion.
Meanwhile Igor Sechin, CEO of Rosneft, has been named chairman of the Saint Petersburg Commodity Exchange, which is focused on commodity trading. Sechin told the World Energy Congress in October, referring to the natural gas markets, that “it was advisable to create an international exchange for the participating countries, where transactions could be registered with the use of regional currencies.” Very similar indeed to China’s approach.
So where does all of this leave us?
What bearing will the migration away from the dollar in terms of a reserve currency and petrodollar usage impact you as a citizen and investor?
How It Should Play Out… And How to Beat It
The tectonic shift away from the petrodollar portends a weaker greenback in the future.
And since oil – arguably the most important actively traded commodity on the planet – is priced in U.S. dollars (for now), it’s easy to see world oil prices continue their steady climb higher.
The downside is that it will likely cost you more at the gas pump. The United States is producing a lot more oil, but the prospects of exporting it will support high prices. Still, this doesn’t have to be a losing proposition.