Oil is the most traded commodity and has always had a major impact on the economy and financial markets. At current oil prices, the oil market is over $4 trillion. Most oil is still traded in U.S. dollars. But now that the dollar has been used as a weapon against Russia, one of the largest oil producers in the world, it remains to be seen whether that will continue. This is not the first time the Americans have cut off a country from international payments. Iran, Sudan and Venezuela — coincidentally all oil producers — suffered the same fate. Given the limited supply, oil prices may continue to rise. That’s good news for oil producers. Today, the United States is also a major oil producer. That’s good news for the U.S. trade balance. Before the shale revolution, half of the trade deficit was oil; now it is less than 15 percent. That shift from $40 billion a month in 2008 to $8 billion a month last year has helped ensure that the U.S. dollar has been relatively strong in recent years.
The United States is not the only oil producer in the world. OPEC’s market share has increased, in part because there has been less investment in new oil production under pressure from the energy transition in the Western world. Incidentally, there is also much less investment within OPEC than there used to be, but that has more to do with the bear market in oil between 2018 and 2020, which eventually culminated in a negative oil price. That lack of investment and OPEC’s increasing power are contributing to an oil price that could remain high for the foreseeable future.
There are roughly three different types of oil producers:
There are oil-producing countries that get along relatively well with the United States. Canada, Mexico, Brazil, and Colombia have floating exchange rates, and the currencies of these countries benefit from higher oil revenues. Much of the money is also reinvested in U.S. assets.
There are also oil-producing countries that spend the money mostly outside the United States, but at the same time can get along reasonably well with the United States. These countries have pegged their currency to the dollar, and with oil prices rising, these countries buy more U.S. Treasuries to guarantee the peg to the dollar. These are countries like Kuwait, the Emirates, Qatar, Nigeria and Saudi Arabia.
There are also countries that do not get along with the United States at all, they convert their dollars into something else as quickly as possible. Russia has tried to get rid of its dollar position as much as possible in recent years and the fact that the Russian central bank can no longer access its dollar reserves in times of crisis will not have increased the incentive to hold dollars as reserves from now on. In addition to Russia, these include countries such as Iran, Iraq, Venezuela and Libya.
Between 2002 and 2008, many petrodollars were converted into a new currency, the euro. This was not only true for the Norwegian Investment Fund or the Libyan Investment Authority; virtually every other entity that benefited from the then-rising price of oil invested in part in euros. Partly as a result, the value of the euro doubled against the dollar between 2000 and 2008.
After the heavy sanctions towards oil producer Russia and the sharp rise in the price of oil, the question is what will oil producers do with their excess oil dollars? At this oil price, the budget is more than covered and there are also enough reserves to defend the currency. They can, of course, invest in the United States, but both the stock market and the housing market have risen sharply and the return on Treasuries adjusted for inflation has also been better at times. Only the moment they buy weapons does the money almost automatically come to Americans. The largest arms producers are in the United States.
A growing proportion of petrodollars are going into the new alternative to the dollar and the euro and that is the renminbi. The Chinese themselves want to get rid of their dependence on the dollar and today much of the oil for China is traded in renminbi. In recent years it has become much easier to trade in Chinese stocks and in Chinese government bonds. They are also reserves beyond the control of the Americans. For countries that don’t get along so well with the Americans, this is a better alternative than holding the reserves in dollars. This process has been going on for some time. There is a reason why the Chinese currency is the best performing currency over the past year, three years, five years and even ten years. Of course, this is not just because of recycled petrodollars. China also has a rising trade surplus. Furthermore, monetary madness has not struck in China either, the PBoC is more like the Buba in its fight against inflation. Incidentally, China still has $3 trillion that in times of need is worth no more than the paper it is printed on. That is still a reasonable amount because 1 million dollars in 100-dollar bills weighs about 10 kilos, so we are talking about 30 million kilos of paper.
Countries in the second group, including Saudi Arabia and even the Emirates, have abstained from voting in condemnation of the Russian incursion. Now that the United States is much less dependent on the Middle East, these countries are trying to secure their future position and the combination of China, Russia and possibly Iran does become a very large geopolitical factor. For these countries, an investment in a structurally rising currency like the renminbi is a very attractive prospect. Chinese government bonds then form the new safe haven and the renminbi can rise further.
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