Oil and the Dollar

Businessworld
Srikanth Srinivas

Here’s another decoupling theory: oil and the dollar. OPEC oil ministers last week said they were considering invoicing oil sales in currencies other than the dollar, mainly the euro. Their driving concern: inflation and the reduced purchasing power of the dollar. The UAE, Qatar and Saudi Arabia also hold large reserves of the currency.

Iran and Venezuela have long been pushing for delinking oil prices from the dollar, but then, those countries are no friends of the US. In any event, Iran invoices 85 per cent of its sales in currencies other than the dollar. But a move from the dollar to a currency basket — Kuwait did it in May this year — might encourage other countries with large dollar holdings to follow suit.

But will invoicing in another currency change anything? The prices of currencies are relative, and prices of tradeable goods such as oil are relative to currencies.


If oil is $50 a barrel, and $1 = 1 euro, then, in euros oil costs 50 euros. If the euro doubles in value so that $2 = 1 euro, a barrel of oil will cost $100, which is still 50 euros. What matters are terms of trade — the ratio of export prices to import prices — not changes in currencies relative to one another.

The terms of trade have worsened for America relative to oil producing countries because America is paying double for oil whereas the oil countries can now buy twice as much from America.

But the terms of trade between the eurozone and oil producing countries do not change because one barrel of oil still costs 50 euros. So if the oil producing countries do not want to hold depreciating dollars, they could sell the currency forward for euros in the futures markets.

Saudi Arabia — the pivotal player in OPEC, which also maintains a close relationship with the US — is not likely move out of the dollar; it vetoed an OPEC move to mention dollar concerns in the cartel’s post-meeting statement. This decoupling theory, too, comes with several qualifications.