Saudis End 50-Year Petrodollar Agreement with the US

Saudi Arabia has decided not to renew its 50-year-old agreement with the United States. This stipulated that the Arab nation would sell its oil on the global market exclusively in dollars, according to various media reports. This decision is part of broader changes in the global financial landscape, highlighting the diminishing influence of the dollar and the rise of a new financial paradigm.

The agreement, commonly known as the Petrodollar Agreement, was signed in 1974, just three years after the United States abandoned the gold standard under President Richard Nixon. This agreement played a crucial role in establishing the US dollar as the world’s primary reserve currency.

A reserve currency is one held in substantial quantities by various governments and institutions for their reserves

It is also used in international trade transactions and for trading major commodities. Following World War II, the US dollar emerged as the primary reserve currency.

The Saudi agreement with the United States expired on June 9, and the Saudis have not announced a renewal. Saudis are increasingly looking eastward and is also planning to join the BRICS countries.

The Agreement was Favourable for Both Countries

For decades, the international oil trade conducted in dollars has been highly advantageous for the United States of America. This practice has generated significant global demand for dollars, helping to maintain the currency’s strength even as the US has substantially increased its national debt and money supply. Additionally, it has led to an influx of capital into the country, as nations often invested their oil revenues in US government bonds. This dynamic has ensured a consistent demand for both US government debt and the dollar

The Petrodollar arrangement has benefited both Saudi Arabia and the United States for decades

The Saudis sold oil to the US and invested in US government bonds, receiving military protection and favourable treatment in the Middle East in return. This arrangement has been a key factor in the relative stability of Saudi Arabia’s governance compared to other Arab countries.

Following the agreement, the United States gained access to Saudi airspace and established military bases there. This facilitated various military operations in the Middle East and enhanced US influence in the region.

Decline in Influence

The shift in Saudi Arabia’s direction is significant as it reflects the waning influence of the United States on the international stage. It also highlights a change in the primary buyers of Saudi oil.

In 2000, the majority of Saudi oil was sold to the USA and Europe, but now the bulk of it goes to China and India. In 2000, 38 percent of Saudi oil exports went to Europe and North America; by 2022, this had dropped to about 18 percent. Conversely, exports to China and India have surged from 6 percent to 48 percent during the same period.

The kingdom’s oil sales are now likely to increase in terms of yuan, euro, rubles, and yen. In fact, Saudi Arabia has been moving in this direction for several years. Early last year, the country’s leaders announced that they might start selling oil in currencies other than the dollar. Currently, most Saudi oil from their oil companies is sold to China, and the Saudis must also maintain good relations with Russia to help regulate oil prices.

In 2018, the Shanghai International Energy Exchange (INE) launched oil futures priced in yuan. This has made it much easier for producers to sell oil in yuan. According to data from China’s customs administration, China imported $56 billion worth of Saudi Arabian oil in 2022, up from $39 billion in 2021.

Last year, Saudi Arabia exported only $17 billion worth of oil to the USA, a decrease of nearly $2 billion compared to five years ago. This decline is partly due to the sharp increase in US oil production over the past few decades, reducing the country’s dependence on imported oil.

The US Dollar Continues to Dominate the Oil Market

While the majority of international oil transactions still occur in dollars, its share is declining. According to the Wall Street Journal, nearly 80 percent of oil sales are conducted in dollars. However, countries like Russia, Iran, Saudi Arabia, and China are increasingly shifting to other currencies for their transactions.

This trend gradually undermines the dollar’s global position, contributing to inflation in the US, putting upward pressure on interest rates, and weakening the American bond market. The latter is particularly significant, as developments in the US government bond market are already steering the world’s leading country towards a debt crisis.

The Saudis have pegged their currency, the riyal, to the US dollar, requiring them to hold sufficient dollar reserves to maintain the exchange rate. However, they have also announced plans to join the mBridge international payments system, an alternative to SWIFT developed by BRICS. This move would allow them to use a non-dollar system for payments in the future if necessary.

The main reason for the slow and gradual shift away from the dollar is largely due to costs and scale. Since the dollar remains widely used, it is advantageous for many countries to continue using it. Additionally, there are currently few viable alternatives; for instance, the Chinese yuan has not yet achieved the necessary global prominence.

Key Takeaways

Saudi Arabia’s decision not to renew its 50-year-old Petrodollar Agreement with the United States marks a significant shift in the global financial landscape. This move reflects the diminishing influence of the US dollar and the rise of a new financial paradigm. Historically, the Petrodollar arrangement has been mutually beneficial, ensuring demand for the dollar and US government bonds, while providing Saudi Arabia with military protection and stability.

However, the kingdom’s strategic pivot towards the East, particularly its increasing oil sales to China and India, signals a broader realignment. The launch of yuan-priced oil futures by the Shanghai International Energy Exchange and Saudi Arabia’s interest in joining the BRICS-led mBridge payments system further illustrate this trend.

While the US dollar still dominates international oil transactions, its share is declining as countries like Russia, Iran, Saudi Arabia, and China explore alternatives. This gradual shift is weakening the dollar’s global position, contributing to inflation, higher interest rates, and a vulnerable US bond market. Despite these changes, the widespread use of the dollar and the lack of strong alternatives have slowed the transition. Yet, as global dynamics continue to evolve, the influence of the dollar may face further challenges in the years to come.