Editor’s note: China has planned to launch a derivatives contract or crude oil futures contract at the Shanghai International Energy Exchange (INE) denominated in Yuan for the last two years. The contract should initially have started at the end of 2015, then, in September 2016 it was again delayed by one year (Henry Sanderson, Financial Times, 15 September 2016).  The contract would now be launched by the end of 2017 (RT, 25 October 2017). Assuming this indeed finally takes place, are we about to witness a challenge to the USD supremacy, all the more so that it is related to oil? What is the petrodollar system that could be thus defied? How does that “petrodollar system” relates to the overall USD supremacy? Which are the actors involved in this specific possible change? What is China’s role? These are some of the questions addressed here.

This article focuses mainly on the petrodollar system, which is at the heart of the U.S. dollar supremacy, and on the challenges it meets. Meanwhile, these trials start outlining potential futures for the international currency system.

As we investigate the possible futures of the USD supremacy in this series of articles, we previously highlighted that some international currency functions have important effects not only on the issuer’s private economic sector but also on its international stance in power terms. These are the store of value function at both the private and the public level and the trade function. In the case of the USD supremacy, the petrodollar system is at the heart of the trade function. We thus here dig deep not only into its role in upholding the dollar’s status as the world’s reserve currency but also into the challenges that this geo-political-economic arrangement is currently facing.

Executive Summary

As we pursue our in-depth analysis of the tests to the US Dollar supremacy so as to foresee the future of the international currency system and the possible resulting political and geopolitical changes, this article, focusing on one of the main pivot of the American currency hegemony, analyses the petrodollar system and the challenges looming over it.

The petrodollar system is at the heart of American power. In a nutshell, the petrodollar system is grounded in the fact that if a country needs oil and oil is priced in dollars, this country has to own dollars or dollar-denominated assets to buy the oil needed. It results from a 1973 agreement between U.S. President Richard Nixon and King Faisal bin Abdulaziz Al Saud of Saudi Arabia, according to which the U.S. bought Saudi oil in USD in exchange for Saudi American protection and purchase of American military equipment. The overall system allowed the U.S. to finance the mounting American debt, effectively sustaining not only the large current account deficits Washington has run but also its various military foreign operations.

The petrodollar system is facing a series of trials, which are likely to further develop in the near to medium-term future. First, geopolitical “rivals” to the U.S., such as Iran, Venezuela or Russia, promote and sign oil trade agreements denominated in currencies others than the USD. Second, China is likely favouring the rise of the Petroyuan. Two main drivers, notably when operating together, would allow for this dynamics to develop. First, by moving towards energy independency, the U.S. is itself de facto buying less oil, which decreases the amount of USD circulating and fragilise the system, unless other countries continue buying their oil in USD. It is the very initial agreement at the start of the petrodollar system that is as stake. Second, and relatedly, China has become the first world importer of oil. It may thus have more leverage with exporting countries, such as Saudi Arabia, to promote the Yuan. Meanwhile, China diversifies its portfolio of suppliers, thus spreading the possible use of its currency when purchasing oil. 

The challenges to the petrodollar system are supported by an array of trade agreements not related to oil, and denominated in currencies other than the USD. The actors involved are not only China, Russia and Iran, but also Turkey and Japan.

In conclusion, we highlight that Beijing, Moscow and Teheran are bound together by a deep convergence of interests that could lead to a profound transformation of the global monetary system.

Full article 3723 words – pdf 17 pages

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Featured image: Shell Oil Refinery at Dusk by James Daisa, Flickr C.C. 2.0 Some rights reserved

About the author:  Leonardo Frisani (MA Paris) focuses currently on challenges to the US Dollar supremacy. Beyond that, his specialisation is in international security, and his main interests are in geopolitics, macroeconomics, climate change, international energy and history.

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