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Tuesday, April 22, 2003

Will you be paying in Dollars or Euros?

I am going to set aside the reasons for this article by George Monbiot and simply publish the following excerpt, with a couple added links:

In November 2000, Saddam Hussein insisted that Iraq's oil be bought in euros. When the value of the euro rose, the country's revenues increased accordingly. As the analyst William Clark has suggested, the economic threat this represented might have been one of the reasons why the US government was so anxious to evict Saddam. But it may be unable to resist the greater danger.

Last year, Javad Yarjani, a senior official at Opec, the oil producers' cartel, put forward several compelling reasons why his members might one day start selling their produce in euros. Europe is the Middle East's biggest trading partner; it imports more oil and petrol products than the US; it has a bigger share of global trade; and its external accounts are better balanced. One key tipping point, he suggested, could be the adoption of the euro by Europe's two principal oil producers: Norway and the United Kingdom, whose Brent crude is one of the "markers" for international oil prices. "This might," Yarjani said, "create a momentum to shift the oil pricing system to euros."

If this happens, oil importing nations will no longer need dollar reserves to buy oil. The demand for the dollar will fall, and its value is likely to decline. As the dollar slips, central banks will start to move their reserves into safer currencies such as the euro and possibly the yen and the yuan, precipitating further slippage. The US economy, followed rapidly by US power, could then be expected to falter or collapse.

Firstly, the fact that the oil price may be demominated in euros does not, of itself, mean that oil will be paid for in that currency; it is hard to imagine that dollars will be refused as payment, making foreign exchange necessary, though this does involves some degree of currency risk. Secondly, if redemomination happens, it is unlikely to be a unanimous OPEC decision--the Venezuelans, for one, sell most of their oil in the United States and, despite Chavez, would probably not want to compromise that relationship. Thirdly, while the US imports a lot of its oil, most of it is either produced domestically or imported from Canada. West Texas Intermediate, Brent North Sea and Light Sweet Crude, traded on the New York Mercantile Exchange as well as London's International Petroleum Exchange, will likely stay in priced in dollars as a result. There is an even more fundamental reason, though, which Yarjani notes:

Because crude oil contracts are currently traded in dollars, and the prices of OPEC crudes are determined by using complex formulas derived from marker crudes, such as Brent and WTI, there is not much the Organization can do unilaterally until, and unless, there is a switch of denomination in these markets. OPEC has no control over the quotations of these marker crudes, whereas, in the past the Organization did set the official selling prices. That has all changed with the introduction of market-related prices which saw the system change from a seller’s to a buyer’s market, or at least where market forces now dictate prices. Moreover, the entire infrastructure of the oil market has been based around the dollar, and that will be hard to displace.

Monbiot's case, it turns out, depends on both Britain and Norway joining the euro, and them subsequently desiring to have Brent North Sea denominated in the new currency. Even so, things may not change much. Yarjani again:

[O]ne should also be aware that the dollar now benefits from its status as an incumbent currency and that the forces of entropy are expected to lend support to the US currency versus the euro. This was the case for the pound sterling long after the UK had lost its economic supremacy. Moreover, confidence in the US economy remains unrivalled, despite the recent slowdown. This level of optimism could mean that capital and investment flows to America will remain strong, from Europe as well.

Just as the creation of the euro was a political decision, so will any change in the marker price of crude oil. Will such a change be dramatic in effect, as Monbiot hopes? That depends on whether the world revolves around oil not now, but when such a change is announced. (How much of world currency exchange is related to oil today is a good question.) Any change is not something that can happen overnight--everyone will see it coming, and they adjust accordingly. So far all it is is an idea, though, and the US most probably will try to see that it stays that way.