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Considering the PetroEuro

Author: Lee Hudson Teslik
December 7, 2007

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Easily missed amid the rising outcry over oil prices is the fact that they have only been skyrocketing in dollar terms. Priced in euros—or yen, or pounds sterling—the cost of a barrel of oil has risen much less over the past decade. At recent meetings of OPEC, the Organization of the Petroleum Exporting Countries, ministers disputed whether oil should be sold in euros instead of dollars (WashPost), in light of the dollar’s recent decline. Officials from Venezuela, Iran, and Algeria called for a switch. But Saudi Arabia and Kuwait, both of which hold huge dollar reserves, urged caution, and the bloc concluded the meetings saying it would further study (FT) the impact of the falling dollar on its member states.

If oil were priced in euros, what would the effect be? On the surface, possibly not much, experts say. “Whether they’re selling in dollars or euros, they can make their currency conversions,” says Peter J. Robertson, vice chairman of Chevron Corporation, in an interview with CFR.org. The fact that major currencies are easily exchanged means that oil producers don’t sustain any immediate monetary loss by accepting payment in one currency or another. Yet a currency switch could bring a slew of more subtle changes. First, there is the psychological impact. Robertson says a shift would send a clear signal that oil producers “didn’t have as much confidence in the future of the United States”—a sentiment that could deeply undermine investor confidence.

This, in turn, could further hamper the strength of the dollar. As Saudi Arabia’s foreign minister says “the mere mention that the OPEC countries are studying the issue of the dollar is itself going to have an impact,” adding that a dollar collapse could take a severe toll on OPEC (UK Telegraph) economies. Indeed, several of the main oil-exporting nations would be among the most vulnerable parties, globally, should the dollar’s value decline. Having accepted dollars in payment for years, countries like Saudi Arabia, Kuwait, and the United Arab Emirates have compiled massive dollar reserves (Economist), rivaling those held by China. They have a compelling interest in keeping those dollar piles as valuable as possible. Other countries, including Iran, have already diversified away (Gulf News) from the dollar, which explains the sharp differences of opinion within OPEC.

Beyond its effect on the dollar, OPEC shifting to the euro could also bring substantial benefits to European countries and companies by reducing currency risk (Guardian) currently built into their trade with oil states. More broadly, an OPEC shift to the euro could bring an overall reduction in global demand for the dollar, taking away one of the main ways in which the United States has financed large budget and trade deficits, as CFR’s Brad W. Setser notes in a recent interview.

The pressing question, then, is whether OPEC will switch. Here, expert opinion is mixed. Pressure from Saudi Arabia, OPEC’s heavyweight, seems likely to keep any immediate switch at bay. Two Lehman Brothers economists write on the website of the Financial Times that Riyadh’s stockpile of petrodollars binds its prospects to the health of the currency. Still, it seems all but certain that more oil states will follow Iran’s lead in diversifying their holdings away from the dollar. Riyadh has substantial support (Bloomberg) in defending the dollar, but Nigeria and Angola, two of Africa’s major oil exporters, are making new efforts to diversify their currency reserves.

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