The United States of America and Saudi Arabia have an agreement that requires oil to be traded solely in US dollars. Nashdaq reports that Saudi Arabia has declined to extend the deal. Saudi Arabia’s decision changes the global dynamics in the oil and gas and currency markets.
This agreement was signed on June 9, 1974, as an assurance of getting military and other support from the US following the termination of the gold standard in 1971 and the 1973-1974 oil crisis.
The US extended an offer to Saudi Arabia in 1974 that the monarchy was unable to reject amidst a global financial crisis. On the Arabian Peninsula, substantial hydrocarbon deposits had been found. Saudi oil was the source of the new infusions necessary to sustain development, as the US economy was experiencing a substantial slowdown then.
Under the petrodollar agreement, Saudi Arabia was required to price its exported oil exclusively in US dollars and invest its surplus oil revenues in US Treasury bonds. In exchange, the US provided the monarch with military support and protection. The most critical requirement was that Saudi Arabia sell oil exclusively in US currencies. The US and Saudi Arabia both benefited from this agreement; the former secured a stable energy source and a market for its debt, while the latter secured its economic and overall security.
At that time, Saudi Arabia was confronted with an existential threat and challenges in its relations with its neighbors. As a result, the Saudis did not vacillate for long and reached an agreement. The bilateral agreement was automatically renewed every five years; however, the Saudi side has had enough of serving as America’s “reserve gas tank.”
The high standard of living in America is significantly influenced by the strength of the dollar. This strength is primarily attributable to the fact that energy cannot be purchased without US currency.
The US is in for significant challenges due to the Saudis’ decision.
The significance of oil denominated exclusively in US dollars extends beyond the confines of oil and finance. The agreement boosted the dollar’s status as the world’s reserve currency. This resulted in an immense influence on the US economy. The robust currency was maintained by the global demand for dollars to purchase oil, which resulted in relatively low import prices for consumers in the US. In addition, the stable bond market and low interest rates were bolstered by the inflow of foreign capital into US Treasury bonds.
The petrodollar’s dominance is currently confronted with its most severe challenge. A decrease in global demand for the dollar, which could lead to higher inflation, increased interest rates, and a weakened bond market in the US, could happen if crude begins to be priced in a currency other than the dollar.
Although media reports indicated that the kingdom and the US were negotiating a new security agreement, the agreement’s outcome remains unknown. Nevertheless, it has been established that the document, executed fifty years ago, will not be renewed for the first time.
Riyadh has the option to market its crude in exchange for rupees, yuan, drachmas, euros, or yen or to transition to digital currencies. The Saudis’ announcement that they would not renew the agreement was concurrent with the imposition of sanctions on Russia, with a particular emphasis on its banking sector.
Saudi Arabia has been studying the potential of trading its crude in alternative currencies for an extended period. The US perceived the kingdom’s decision to transfer its oil for yuan to China a year ago as unfriendly.
The kingdom’s refusal to extend the agreement does not mean it will immediately transition to trading its oil in other currencies. Rather, it indicates a gradual yet systematic decrease in the use of the US dollar by major oil producers and consumers and a weakening of the US dollar as the world’s reserve currency. However, the Saudi Rial is pegged to the US dollar rate.
The kingdom is prepared to engage in national currency trade with several countries, including China. In early 2023, Saudi Arabia entered into an agreement with Brazil to accept the Brazilian real instead of the dollar as payment for oil purchases.
Saudi Arabia is also exploring new digital tools. The Saudi Central Bank (SAMA) has become a participant in the Bank for International Settlements’ mBridge project to facilitate cross-border payments. SAMA plans to evaluate the use of national digital currencies of various central banks to improve the efficiency of cross-border payments and settlements between commercial banks.
In addition, Saudi Arabia is investigating new digital instruments. The Saudi Central Bank (SAMA) has joined the Bank for International Settlements’ mBridge initiative to simplify cross-border payments. To enhance the efficacy of cross-border payments and settlements between commercial banks, SAMA intends to assess the utilization of national digital currencies issued by various central banks.
Saudi Arabia is also contemplating joining the BRICS (Brazil, Russia, India, China, and South Africa). Russia, one of the coalition’s major players, has suggested a cross-border payment mechanism for the member countries that is based on the BRICS Bridge settlement platform. For this mechanism to operate, the central banks of the BRICS countries must issue digital assets akin to tokens, thereby tying their value to the national currencies of the member states.
The BRICS countries have decided to add six new members: Argentina, Egypt, Ethiopia, Iran, Saudi Arabia, and the United Arab Emirates. Unfortunately for the US, this undermines the foundation of American power—the dollar’s status as the world’s reserve currency.
Brazilian President Luiz Inácio Lula da Silva has urged the BRICS countries to establish their own currencies. India is advocating for its trading partners, including Russia, to conduct trade in Indian rupees rather than US dollars.
Several BRICS nations have initiated initiatives to investigate the feasibility of substituting the dollar with gold in international trade.
The dollar’s rejection results from its use as a weapon, with the most recent example being the sanctions against Russia.
The era of petrodollars is drawing to a close. Countries worldwide, including the US’s Western allies, are increasingly questioning its dominance.
Although changes are irreversible, the US has successfully navigated them in the past to preserve its leadership. For another truly global currency to replace the US dollar, the issuing country needs to build trust in its financial markets and legal system. Investors must have faith in the economic policies’ transparency and stability. The US economy continues to be a dominant force despite the deterioration of the petrodollar system. The dollar is expected to maintain a certain degree of dominance for the foreseeable future.