Category: Oil-rent
The economics (and politics) of oil
First published in:
Academic rigour, journalistic flair
Rutledge, E. J. (2024, July 9). How the economics of oil could sway the US presidential election. The Conversation. https://theconversation.com/how-the-economics-of-oil-could-sway-the-us-presidential-election-232956
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Oil continues to influence global economics and politics like no other finite natural resource. In the 2024 US presidential election, the strategic commodity will be an important domestic issue.
As the biggest producer and consumer of oil on the planet, the US has a particularly strong relationship with the black stuff. And the candidates know it.
Donald Trump has promised to “drill, drill, drill” and reportedly courted the financial backing of industry giants. Those giants have responded by donating US$7.3 million (£5.7 million) to Trump’s campaign – three times more than for his 2020 run.
Meanwhile, Joe Biden has attempted to reduce dependence on fossil fuels with his green energy policy and other legislation. Yet at the same time he has overseen an increase in domestic oil production and promised motorists he will keep petrol prices low.
It’s an important promise in the US, a country whose love affair with cars is well known. Out-of-town shopping malls, long highways and a lack of government investment in public transportation have fuelled car dependency, with many cities being designed around huge road systems.
So it is perhaps unsurprising that pump prices are a significant factor influencing voters. Research has even shown that gasoline prices have an “outsized effect” on inflation expectations and consumer sentiment. As fuel prices go up, confidence in the economy goes down.
And while many European and Asian countries have shifted towards alternative energy sources, the US has not reduced its dependence on fossil fuels when it comes to transport. Electric models make up only 8% of vehicles sold in the US, compared to 21% in Europe and 29% in China.
Any rise in gasoline prices ahead of the US summer “driving season” – when holidays and better weather encourage more road travel and gasoline consumption is estimated to be 400,000 barrels per day higher than other times – would be a serious concern for the Democratic party.
Yet it’s also true that whoever is in the White House actually has limited ability to influence gasoline prices. Around 50% of the pump price is the cost of crude oil, the price of which is set by international markets.
And despite producing enough oil domestically to cover its consumption, the US continues to trade its oil around the world. Back in 2015, Congress voted to lift restrictions on US crude oil exports that had been in place for four decades, allowing US companies to sell their oil to the highest international bidder.
To complicate things further, some US refineries can only deal with a certain type of crude oil, which has to be imported. Neither international events or foreign production decisions are under the control of a US president.
Indeed, oil price spikes caused by political crises in other oil producing regions illustrate how continued dependence on oil itself, whether domestically produced or imported, leaves the US exposed to global market shocks which could in turn influence electoral outcomes.
After Russia’s full scale invasion of Ukraine in 2022 and production cuts from countries such as Saudi Arabia in 2023, the Republican party used a rise in gasoline prices to attack Biden’s environmental policies which had reduced domestic oil drilling and ended drilling leases in the Arctic.
Big oil, little oil
So while the US president has little say over the price of fuel that voters pay, domestic oil and gas regulations have a role to play, as oil producers make up a significant body of influence in the US.
Aside from the big firms backing Trump, the structure of the US oil industry is unique among oil producing states in that it is dominated by a very large number of small independent producers who earn money from the extraction and sale of oil from their land.
In most oil-producing countries, subsurface oil is owned by the state. But in the US, the mineral rights are owned by the private landowner who can earn royalties by allowing oil companies to drill on their land. In 2019, there were 12.5 million royalty owners in the US. Operating alongside them are some 9,000 independent fossil fuel companies which produce around 83% of the country’s oil and account for 3% of GDP and 4 million jobs.
Those companies drilling on state-owned land pay a royalty rate to the government, which up until recently was as low as 12.5% of the subsequent sales revenue. Biden’s decision to raise the rate to 16.67% did not go down well with oil producers.
Despite that raise and Biden’s pledge to forge ahead with the US energy transition, the domestic oil and gas industry expansion has continued under his watch. In 2023, US oil production grew to unprecedented levels, averaging 12.9 million barrels per day and forecasters predict a 2% production increase in 2024.
Surging US oil production may help with the Democrats’ re-election bid, but rising gasoline prices will not – even though their levels depend on much more than Biden’s energy policies. Instead, it may be that the international economics of oil markets drive voters’ decisions – and determine who wins and who loses in November 2024.
COP & the UAE
First published in:
Academic rigour, journalistic flair
Rutledge, E. J., & Zabala, A. (2023, November 27). COP28: inside the United Arab Emirates, the oil giant hosting 2023 climate change summit. The Conversation. https://theconversation.com/cop28-inside-the-united-arab-emirates-the-oil-giant-hosting-2023-climate-change-summit-217859
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The United Arab Emirates (UAE), the world’s seventh largest oil producer, will host the 28th UN climate change summit (COP28) in Dubai from November 30 to December 12. Presiding over the conference will be the chief executive of the UAE state-owned oil company Adnoc, Sultan al-Jaber.
Given fossil fuels account for nearly 90% of the carbon dioxide emissions driving climate change, many have argued that there is a clear conflict of interest in having oil and gas producers at the helm of climate talks. The UAE is alleged to flare more gas than it reports and plans to increase oil production from 3.7 million barrels a day to 5 million by 2027.
Some contend that the oil and gas industry could throw the brake on greenhouse gas emissions by investing its vast revenues into plugging gas flares and injecting captured carbon underground. But independent assessments maintain that the industry will need to leave at least some of its commercially recoverable reserves permanently underground to limit global warming. No oil-exporting country but Colombia has yet indicated it will do this.
Dubai appears determined to undermine even this small victory. An investigation has released documents showing the UAE hosts planned to advise a Colombian minister that Adnoc “stands ready” to help the South American country develop its oil and gas reserves.
The UK invited ridicule by expanding its North Sea oil fields less than two years after urging the world to raise its climate ambitions as summit host. The UAE seems destined for a similar fate – before its talks have even begun.
Oil consumption & dependence
The UAE’s fast-growing population of 9.9 million (only 1 million are Emirati citizens) has the sixth highest CO₂ emissions per head globally.
Citizens are used to driving gas-guzzling cars with fuel priced well below international market rates and using air conditioning for much of the year thanks to utility subsidies. Visiting tourists and conference-goers have come to expect chilled shopping malls, swimming pools and lush golf greens that depend entirely on energy-hungry desalinated water.
Despite decades of policies aimed at diversifying the country’s economy away from oil, the UAE’s hydrocarbon sector makes up a quarter of GDP, half of the country’s exports and 80% of government revenues. Oil rent helps buy socioeconomic stability, for instance, by providing local people with public-sector sinecures.
This state of affairs is a central tenet of the Arabian Gulf social contract, in which citizens of the six gulf states mostly occupy bureaucratic public sector positions administering an oil-based economy with expatriate labour dominating the non-oil private sector.
Tech-fixes, targets and the future
How does the UAE plan to cut its own emissions? Adnoc and other international oil companies are banking on select technologies (to sceptics, “green cover” for further climate damage) to preserve their core business model: extracting oil.
Adnoc, along with the wider oil and gas industry, has invested in carbon sequestration and making hydrogen fuel from the byproducts of oil extraction. According to the Intergovernmental Panel on Climate Change (IPCC), such measures, even if fully implemented, will only have a small impact on greenhouse gas emissions.
The UAE was the first in the Middle East to ratify the Paris climate agreement and to commit to net zero emissions by 2050. With near limitless sunshine and substantial sovereign wealth, the UAE ranks 18th globally per capita and first among Opec countries for solar power capacity. Solar now meets around 4.5% of the UAE’s electricity demand and projects in the pipeline will see output rise from 23 gigawatts (GW) today to 50GW by 2031.
The Barakah nuclear power plant (the Arab world’s first) started generating electricity in 2020. While only meeting 1% of the country’s electricity demand, when fully operational in 2030, this may rise to 25%.
The oil sector is inherently capital-intensive, not labour-intensive, and so it cannot provide sufficient jobs for Emiratis. The UAE will need to transition to a knowledge-based economy with productive employment in sectors not linked to resource extraction.
In the UAE, sovereign wealth fund Mubadala is tasked with enabling this transition. It has invested in a variety of high-tech sectors, spanning commercial satellites to research and development in renewable energy.
But even if the UAE was to achieve net zero by some measure domestically, continuing to export oil internationally means it will be burned somewhere, and so the climate crisis will continue to grow.
Self-interest
Is disappointment a foregone conclusion in Dubai? Already one of the hottest places in the world, parts of the Middle East may be too hot to live within the next 50 years according to some predictions.
Rising temperatures risk the UAE’s tourism and conference-hosting sectors, which have grown meteorically since the 1990s (third-degree burns and heatstrokes won’t attract international visitors). A show-stopping announcement to further its global leadership ambitions is not out of the question.
At some point, one of the major oil-exporting countries must announce plans to leave some of its commercially recoverable oil permanently untapped. COP28 provides an ideal platform. A participating country may make such a commitment with the caveat that it first needs to build infrastructure powered by renewable energy and overhaul its national oil company’s business model to one that supplies renewable energy, not fossil fuel, globally.
The UAE has the private capital and sovereign wealth required to build a post-oil economy. But will it risk being the first mover?
China & the Arabian Gulf
First published in:
Academic rigour, journalistic flair
Rutledge, E. J. (2022, December 22). China’s increasing economic ties with the Gulf states are reducing the west’s sway in the Middle East. The Conversation. https://theconversation.com/chinas-increasing-economic-ties-with-the-gulf-states-are-reducing-the-wests-sway-in-the-middle-east-196518
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At the end of November 2022, UK prime minister Rishi Sunak announced that the “golden era” between Great Britain and China was over. China may not have been too bothered by this news however, and has been busy making influential friends elsewhere.
In early December, Chinese president Xi Jinping met with the Gulf Cooperation Council (GCC) – a group made up of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates – to discuss trade and investment. Also on the agenda were talks on forging closer political ties and a deeper security relationship.
This summit in Saudi Arabia was the latest step in what our research shows is an increasingly close relationship between China and the Gulf states. Economic ties have been growing consistently for several decades (largely at the expense of trade with the US and the EU) and are specifically suited to their respective needs.
Simply put, China needs oil, while the Gulf needs to import manufactured goods including household items, textiles, electrical products and cars.
China’s pronounced growth in recent decades has been especially significant for the oil rich Gulf state economies. Between 1980 and 2019, their exports to China grew at an annual rate of 17.1%. In 2021, 40% of China’s crude oil imports came from the Gulf – more than any other country or regional group, with 17% from Saudi Arabia alone.
And the oil will likely continue to flow in China’s direction. In 2009, it was predicted that China would require 14 million barrels of oil per day by 2025. In fact, China reached that figure in 2019 and is expected to need at least 17 million barrels per day by 2040. At the same time, the US became a net oil exporter in 2019 and thus achieved a longstanding foreign policy goal: to overcome its dependence on Middle Eastern fossil fuels.
China has benefited from increasing demand for its manufactured products, with exports to the Gulf growing at an annual rate of 11.7% over the last decade. It overtook the US in 2008 and then the EU in 2020 to become the Gulf’s most important source of imports.
These are good customers for China to have. The Gulf economies are expected to grow by around 5.9% in 2022 (compared with a lacklustre 2.5% predicted growth in the US and EU) and offer attractive opportunities for China’s export-orientated economy. It is likely that the fast-tracking of a free trade agreement was high on the summit’s agenda in early December.
Strong ties
The Gulf’s increased reliance on trade with China has been accompanied by a reduction in its appetite to follow the west’s political and cultural lead.
As a group, it was supportive of the west’s military action in Iraq for example, and the broader fight against Islamic State. But more recently, the Gulf notably refused to support the west in condemning Russia’s invasion of Ukraine. It also threatened Netflix with legal action for “promoting homosexuality”, while Qatar has been actively banning rainbow flags supporting sexual diversity at the FIFA men’s World Cup.
So Xi’s visit to Saudi Arabia was well timed to illustrate a strengthening of this important partnership. And to the extent that anything can be forecast, a deepening of the Gulf-China trade relationship seems likely. On the political front, however, developments are less easy to predict.
China is seeking to safeguard its interests in the Middle East in light of the Belt and Road initiative, its ambitious transcontinental infrastructure and investment project.
But how much further might the Gulf states be prepared to sacrifice their longstanding security pacts with western powers (forged in the aftermath of the second world war) in order to seek new ones with the likes of Beijing? Currently, America has military bases (or stations) in all six Gulf countries, but it is well documented that the GCC is seeking ways to diversify its self-perceived over-reliance on the US as its primary guarantor of security (a sentiment within the bloc that was pronounced while Obama was president, less so with Trump, but on the rise again with Biden).
In the coming period, the GCC will need to decide which socioeconomic path to pursue in the post-oil era where AI-augmented, knowledge-based economies will set the pace. In choosing strategic ties beyond trade alone, the Gulf states must ask whether the creativity and innovative potential of their populations will be best served by allegiances to governments which are authoritarian, or accountable.
Imperial interfering
Working in the shadows
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US ports deal: A bitter aftertaste
First published in:
Rutledge, E. J. (2006, August 19). US ports deal: A bitter aftertaste. Al Jazeera. https://www.aljazeera.com/news/2006/4/19/us-ports-deal-a-bitter-aftertaste
As a consequence of the furore by the US congress over DP World’s acquisition of several American ports, the Dubai state-owned company decided to avert a long legal battle and agreed to put these assets up for sale.
That DP World had already sought and obtained the necessary US regulatory approvals did little to temper the irrational concerns expressed by many American commentators.
Congressional concerns were not over DP World’s business plan or its security record – the US navy has been using Jebel Ali for more than 15 years – but were almost exclusively because it was an Arab company. It is clear, though, from a brief review of the regional and international press, that the consensus view is that congress was unnecessarily discriminatory and in the wrong.
It happens that many other US ports are owned and/or operated by foreign companies, many of which are Asian. According to the New York Times, foreign-based entities own over 30% of America’s ports. Over 80% of Los Angeles’s port terminals are run by foreign companies. A Singapore state-controlled company operates Pacific coast ports from Los Angeles to Alaska.
In a similar incident last year the Chinese energy company CNOOC had to give up its bid to take over Unocal as a result of US congress disquiet. At the time America was accused of hypocrisy. On the one hand it was, and still is, advocating free trade as the global panacea and on the other protecting its own back yard; the DP World affair will only compound this sentiment. In other respects America is likely to lose out from its treatment of DP World.
There is little doubt that the decision will deter other GCC investors from US acquisitions. America will also find it harder to win support for its much-hyped Middle East free-trade area and at the very least the timetable for negotiating a free-trade agreement with the UAE will be put back.
Advantage Dubai
DP World expects to raise about $750m from the sale of its recently acquired US assets. Its US ports business operates five container terminals and handles cargo and passengers at a number of other sites. Since these operations accounted for around 10% of P&O’s annual global turnover and are less profitable than other operations in emerging markets, the company will make a tidy profit if it realises its asking price.
The US ports sector can hardly be viewed as having as high a growth potential as P&O’s Asian assets, as it is a mature market. The forced sale will also mean that the company will have more money and time to concentrate on the more lucrative emerging markets of Asia.
Despite the sale of its US assets DP World is now the third-largest port operator in the world. DP World has gained huge amounts of free publicity and a fair deal of sympathy. The company, which is borrowing $6.5bn to fund its takeover of P&O, had received commitments of over $14bn by March 20 and this is a clear sign that the episode in America has done nothing to dampen investor confidence in the company’s future prospects.
Although on a much smaller scale, it is somewhat ironic that another government of Dubai-controlled investment body, Istithmar, has bought into the US ports business this year. In January Istithmar bought Inchcape Shipping Services for $285m. Inchcape has various interests in America and, for instance, works with the customs department in the key ports of New York and San Francisco.
Turning to the UAE-US free-trade agreement, on the face of it the US stands to benefit more than the UAE from a bilateral agreement. US companies stand to gain in the short term, as most bilateral trade comprises US exports to the UAE. If the agreement fails as a result of the DP World fiasco, it would represent a considerable blow for American economic interests.
Nevertheless, the UAE will no doubt act pragmatically and if it considers the longer-term benefits of a free-trade agreement, such as increased levels of US inward investment, as credible, it is likely that it will still go ahead. GCC states will still invest in the US, but may decide to do so in the more traditional behind-closed-doors fashion.
By forming partnerships and not seeking to acquire controlling stakes, GCC investment bodies can make strategic investments without incurring political costs. According to an Abu Dhabi Investment Authority executive, the authority is not going to stop buying assets in the US, however ADIA will increasingly be looking East for longer-term investment opportunities.
Disadvantage USA
US misguided anti-Arab sentiment will not only tarnish America’s reputation as a free-trade nation but by making it harder for Arab governments to invest in the US may well deter the process of petrodollar recycling – something which since the collapse of Breton Woods has greatly benefited the American economy.
Sultan Bin Nasser al-Suwaidi, the UAE’s central bank governor, said that “trade and investment relations with the United States must now be viewed from a new perspective”. Many analysts, including some from the US, have said that the DP World affair may set a damaging precedent and deter investors, particularly from the Middle East, from investing in the US.
The US economy would inevitably suffer if petrodollars did not filter back into its economy and were instead converted into euros or yen. Mohammed Sharaf, the DP World chief executive, recently said that other foreign companies could be put off investing in the US by DP World’s experience, especially oil-rich Arab states.
Asian exporting economies and Opec states seem less willing simply to hold their US dollar assets in treasury bonds and are looking for better returns by buying fixed assets such as companies and property.
For example, another Dubai government-owned company, Dubai International Capital, is in the process of buying Doncasters, a UK-based aerospace manufacturer, for $1.2bn. The takeover is relevant because Doncasters has various interests in US military weapons programmes, including the Joint Strike Fighter.
Dubai International Capital’s takeover of Doncasters has yet to receive much media attention in America, but if it does and the attention is similar to that DP World received it will further tarnish America’s free-trade reputation and the US will be seen as increasingly hypocritical.
[As Aljazeera then put it: “Emilie Rutledge is a British economist who is currently based at the Gulf Research Center in Dubai”]
Sukuk Rising Fast in Popularity
First published in:
Rutledge, E. J. (2005, November 3). Sukuk Rising Fast in Popularity Arab News. https://www.arabnews.com/node/282634
The Islamic bond (Sukuk) is fast rising in popularity and so lucrative is the potential market that conventional international banks are falling over themselves to set up Shariah-compliant operations. With abundant oil-windfall revenues and a raft of infrastructure mega projects either underway or on the drawing board, the Gulf is fast becoming the logical choice for new and established players alike to set up shop.
As conventional bonds are “off limits” to Muslims because interest is paid to those who invest in them, the Gulf debt market was until recently underdeveloped. This is changing because Sukuk offer a share in the proceeds from a business venture rather than paying out interest.
Bahrain has been a leading “offshore” banking center for decades and its central bank, the Bahrain Monetary Agency, is one of the pioneers of Islamic banking. However, until recently, the “capital” of Islamic finance was Malaysia. Competition is certainly building up, Swiss banks are now making efforts to understand, embrace and implement some elements of Islamic finance and the UK’s chancellor of the exchequer, Gordon Brown, has said that he wants London to become the global Islamic finance center.
The latest Sukuk deal from the Gulf Cooperation Council (GCC) bloc is Saudi Basic Industries Corp’s (SABIC’s) $800 million issue. This is significant because it is the first Saudi Sukuk to be issued under the new Capital Market Law and the debt market in the Kingdom is relatively untapped. If SABIC becomes a Saudi trendsetter, there is no doubt that the GCC will become the global hub for Islamic finance. The only question is if the likes of Merrill Lynch and Goldman Sachs will pitch their headquarters in Dubai, Manama or Riyadh? According to the Islamic Finance Information Service, there were three key players in terms of issuing Sukuk in 2005 — GCC countries, Malaysia and Pakistan. To date, most Sukuk have been corporate, not sovereign. For instance, the only major sovereign bond issue in the GCC countries during 2005 was by the government of Bahrain ($79.5 million). It therefore follows that the potential Middle Eastern sovereign Islamic bond market could be huge in the future.
In 2005, a Malaysian company, Jimah Energy Ventures, issued the largest Sukuk for the year — $1.27 billion; Malaysian companies also issued the second and third biggest Sukuk last year (Musyarakah One Capital’s Sukuk for $658 million and PLUS Expressway’s for $634 million). However, the tables turned in early 2006 with DP World launching the largest Sukuk in history. The $3.5 billion issue by Dubai Ports, received more than $11 billion in subscriptions! The Malaysian bank, Commerce International Merchant Bankers, was the leading Sukuk manager (as of Q2 2005) with $1.39 billion, but the UAE’s Dubai Islamic Bank was in third place having managed three Sukuk worth $633 million. Interestingly, and indicative of the trend in conventional banks moving into Islamic finance, HSBC Amanah was last year’s second most important Sukuk manager having helped various entities raise $ 882 million, in seven separate issues.
The overall pool of assets managed by Islamic banks, according to estimates by Reuters, is between $250 billion and $400 billion. Over the past five years the Sukuk market has grown significantly — the latest data from Bahrain’s Liquidity Management Center indicates that there is almost $ 18 billion worth of outstanding issues; of this, no less than 52 percent originates from the GCC countries.
Various changes have taken place or continue to take place and all bode well for the Gulf’s nascent financial centers. The first is that much more of the region’s oil windfall revenues are being retained within the region than in previous oil booms. Ongoing reforms, particularly in the region’s real estate sectors, are attracting significant levels of this retained capital. The second is the region’s increasingly bullish private sector. All regional governments are investing heavily in their respective infrastructures and unlike the past, most of today’s projects are generating growth, and not white elephants.
Thirdly, governments and regulators in various GCC countries are being proactive in promoting Islamic banking and are developing custom-built regulatory frameworks, rather than simply following Malaysia’s lead. Combined, these changes mean that more local entities are seeking to raise money via Sukuk issuance and domestic investors are more willing to invest in such bonds. Many of the Sukuk issued in the Gulf till now have been oversubscribed due to high demand, but many more are in the pipeline. The head of Islamic Finance at the Dubai International Financial Center, Khalid Yousaf, estimates that the GCC countries are likely to see another $9 billion worth of new Sukuk between now and the end of the year. Many of the Gulf Sukuk that are open to foreign subscribers are not just attracting Middle Eastern and Asian investors, but increasingly European and US ones too. Furthermore, Western companies are also starting to seek Islamic debt. For instance, the Gulf East Cameron Partners from the United States recently became the first American firm to issue a Sukuk ($166 million).
As the sophistication of Shariah-compliant products increase (particularly the emergence of a secondary market for trading issued Sukuk, as is happening in Dubai and Manama), a far higher number of Muslims and Islamic countries will opt for Sukuk as opposed to conventional bonds. And, why not? For all intents and purposes, the financial returns are comparable; the only real difference is that one is just that bit more ethical than the other.
(Emilie Rutledge is an economic researcher at the Gulf Research Center in Dubai.)
The dollar declines, while the euro shines
First published in:
Rutledge, E. J. (2006, May 28). The dollar declines, while the euro shines. Khaleej Times. https://www.khaleejtimes.com/business/the-dollar-declines-while-the-euro-shines
The dollar is once again losing value, and has depreciated by seven per cent against the euro since the start of the year. How far it will go is anybody’s guess, but the odds are, it will fall further.
Li Yong, China’s Vice-Minister of Finance, has talked of a possible further 25 per cent fall. According to some estimates the amount the United States now owes to the rest of the world now stands at $3 trillion. This, not anything else, is the prime reason for the dollar’s decline.
Although the Federal Reserve does not want to see the dollar collapse, it probably views any dollar devaluation as a convenient way of partially reducing the US’ huge current account deficit. If the dollar declines so will the ‘value’ of the deficit. However, a falling dollar does not bode well for the GCC. It will exacerbate inflation as European and Japanese goods become more expensive and it will also result in a depreciation of the ‘real’ value of the region’s reserve holdings. In addition, because oil and gas are priced and sold in dollars the GCC also stand to loose some revenues in this respect also.
Nevertheless, we have seen only a limited response to these currency conundrums in the form of Kuwait’s decision to allow its currency to appreciate marginally against the dollar. There has been talk from several of the region’s central bankers about a possible realignment in their foreign reserve holdings but as yet no concrete action has been announced. For the time being at least, any speculation that other GCC states were about to follow Kuwait’s lead have been discounted. Both the Saudi Arabian Monetary Authority and the Central Bank of Oman came out and publicly defended the status quo.
Apart for arguments such as ‘providing stability’ and ‘eliminating intra-regional exchange rate risk’ (all 6 GCC states are pegged to the US dollar, albeit Kuwait maintains a more flexible band within which to fluctuate), there is another argument for maintaining the dollar peg. And that is that the collective peg is an interim step towards forming a single GCC currency in 2010. Having a joint peg is a good thing, as it eliminates exchange rate risk within the bloc, but it could just as easily be achieved with a joint peg to the euro or a trade weighted basket of currencies.
Happy creditors no more? For many years Asian central banks, particularly those of China and Japan, have been willing to finance US deficits despite the risks, in order to support their own export-led growth models. However, the scale of financing (subsidising) required to sustain the US’ current account deficit may soon exceed their absorptive capacities. A law of diminishing returns also comes into play; there comes a point when alternative economic growth models look more appealing that accumulating ever greater numbers of underperforming US Treasury Bonds.
The current situation is somewhat perplexing, the country that controls the world’s de facto reserve currency, also happens to be the world’s largest debtor. In any other walk of life, you would be forgiven for being somewhat wary if lending to someone with huge debts. The US like any other debtor may be tempted to use (or not do anything much to prevent) devaluation to reduce external deficit, and this is hardly a desirable trait for a reserve currency.
The dollar has been the dominant reserve currency for at least the past half century and will no doubt continue to be one for some time to come. It can however no longer take this role for granted. One thing is constant in history and that is nothing remains the same forever. Back in the early 1990s after a period where the dollar devalued considerably, many economists at the time speculated about the dollar’s role as the world’s de facto reserve currency. The dollar, nevertheless rebounded, and continued to play its role, in part because there was no viable alternative.
This has changed. Today we have the euro (tomorrow perhaps, even the Yuan). In general for a currency to qualify as a reserve one it needs to meet several criteria including being backed by a large economy, which itself has free flows of capital, open and deep financial markets and low inflation. The euro zone has all of these characteristics and to top it all, it runs a current account surplus.
Those who switch first stand to gain the most: It is now estimated that the US’ deficit consumes no less than two thirds of the worlds total current account surplus. Joseph Stiglitz, a f ormer head of the IMF, recently pointed out that there is obviously something peculiar about a global financial system in which America borrows more than $2 billion each and every day from other countries (in March the US’ Trade Deficit was $62bn) whilst lecturing them on fiscal responsibility.
One could view the current state of affairs as a bit like the classic ‘prisoner’s dilemma’. If any one Asian central bank switched its reserves into euros tomorrow it would undoubtedly benefit vis-à-vis the others, but if they all attempted to switch at the same time they would collectively see the value of their reserves fall considerably, as the resulting run on the dollar would adversely affect all that hold it in reserve.
Reactionary tendencies will probably mean that the GCC dollar peg remains for the time being but there is a strong and growing argument for a move away from too much dependence on the dollar. If Gulf central banks were to buy euros today with some of their dollars reserves, they would get far better exchange rates than if they were to wait for Asian central banks to make the move first.
It is surely worth the while of the GCC’s central bankers to seriously consider alternative options to the current status quo, it would be a shame if the considerable economic achievements of the past few years are washed away by maintaining a rigid dollar peg that may be extremely expensive to maintain and cause unnecessary inflation.- (Emilie Rutledge is an economist with Gulf Research Centre)
Iran – a threat to the petrodollar?
First published in:
Rutledge, E. J. (2005, November 3). Iran – a threat to the petrodollar? Al Jazeera. https://www.aljazeera.com/news/2005/11/3/iran-a-threat-to-the-petrodollar
Iran’s decision to set up an oil and associated derivatives market next year has generated a great deal of interest.
This is primarily because of Iran’s reported intention to invoice energy contracts in euros rather than dollars.
The contention that this could unseat the dollar’s dominance as the de facto currency for oil transactions may be overstated, but this has not stopped many commentators from linking America’s current political disquiet with Iran to the proposed Iranian Oil Bourse (IOB).
The proposal to set up the IOB was first put forward in Iran’s Third Development Plan (2000-2005). Mohammad Javad Assemipour, who heads the project, has said that the exchange will strive to make Iran the main hub for oil deals in the region and that it should be operational by March 2006.
Geographically Iran is ideally located as it is in close proximity to major oil importers such as China, Europe and India.
It is unlikely, in the short term at least, that large numbers of energy traders will decamp and set up shop in Iran; a country which happens to be categorised as a member of the “axis of evil” by the president of the world’s largest oil-importing country; the United States.
But over time, Iran could take some business away from the two incumbent energy exchanges, the International Petroleum Exchange and the New York Mercantile Exchange who both invoice sales solely in dollars.
Economic motives
If successful, the IOB will provide Iran with concrete economic benefits especially if it invoices at least some of its energy contracts in euros.
Iran has around 126 billion barrels of proven oil reserves about 10% of the world’s total, and has the world’s second largest proven natural gas reserves.
From an economic perspective, invoicing oil in euros would be logical for Iran as trade with the euro zone countries accounts for 45% of its total trade. More than a third of Iran’s oil exports are destined for Europe, while oil exports to the United States are non existent.
The IOB could create a new euro denominated crude oil marker, which in turn would enable GCC nations to sell some of their oil for euros. The bourse should lead to greater levels of foreign direct investment in Iran’s hydrocarbon sector and if it facilitates futures trading it will give regional investors an alternative to investing in their somewhat overvalued stock markets.
Euro zone countries alone account for almost a third of Iran’s imports and currently Iran must exchange dollars earned from hydrocarbon exports into euros which involves exchange rate risk and transaction costs.
The decline in the dollar against the euro since 2002 – some 26% to date – has substantially reduced Iran’s purchasing power against its main importing partner.
If the decline continues, more states will increase the percentage of euros vis-à-vis the dollar they hold in reserve and in turn this will increase calls both in Iran and the GCC to invoice at least some of their oil exports in euros.
A move away from the dollar and a strengthening of the euro would further benefit Iran as according to a member of Iran’s Parliament Development Commission, Mohammad Abasspour, more than half of the country’s assets in the Forex Reserve Fund are now euros.
It is primarily the US which stands to lose out from any move away from the petrodollar status quo, it is the world’s largest importer of oil and a move away from invoicing oil in dollars to euros will undoubtedly have a negative effect on its economy.
Fewer nations would be willing to hold the dollar in reserve which would cause a significant devaluation and result in the loss seigniorage revenues. In addition, US energy-related companies stand to lose out as they will be unable to participate in the bourse due to the longstanding American trade embargo on Iran.
Political considerations
In the 1970s, not long after the collapse of the gold standard, the US agreed with Saudi Arabia that Opec oil should be traded in dollars in effect replacing the gold standard with the oil standard.
Since then, consecutive US governments have been able to print dollar bills and treasury bonds in order to paper over huge current account and budgetary deficits, last year’s US current account deficit was $646 billion.
Needless to say, the current petrodollar system greatly benefits the US; it enables it to effectively control the world oil market as the dollar has become the fiat currency for international trade.
In terms of its own oil imports, the US can print dollar bills without exporting commodities or manufactured goods as these can be paid for by issuing yet more dollars and T-bills.
George Perkovich, of the Washington based Carnegie Endowment for International Peace, has argued that Iran’s decision to consider invoicing oil sales in euros is “part of a very intelligent strategy to go on the offense in every way possible and mobilise other actors against the US.”
This viewpoint however, ignores Iran’s economic motives, just because the decision, if eventually taken, displeases the US does not mean that the rationale is purely political.
In light of such sentiments and the US’s current insistence that Iran be referred to the UN Security Council Iran must consider and weigh carefully the economic benefits against the potential political costs.
Although a matter of conjecture, some observers consider Iran’s threat to the petrodollar system so great that it could provoke a US military attack on Iran, most likely under the cover of a preemptive attack on its nuclear facilities, much like the cover of WMD America used against Iraq.
In November 2000, Iraq began selling its oil in euros, its Oil For Food account at the UN was also transferred into euros and later it converted its $10 billion UN held reserve fund into euros.
At the time of the switch many analysts were surprised and saw it as nothing more than a political statement, which in essence it may have been, but the euro has gained roughly 17% over the dollar between then and the 2003 US invasion of Iraq. Perhaps unsurprisingly, since the US led occupation of Iraq its oil sales are once again being invoiced in dollars.
The best policy choice for Iran would be to proceed with the IOB as planned as the economic advantages of such a bourse are clear, but in order to mitigate against the potentially greater political “threat” should provide customers with flexibility.
It would make it much harder for America to object to the new bourse, overtly or covertly, if Iran allows customers to decide for themselves which currency to use when purchasing oil, such an approach would facilitate for euro purchases without explicitly ruling out the dollar.
[As Aljazeera then put it: “Emilie Rutledge is a British economist who is currently based at the Gulf Research Center in Dubai”].