In a significant move, Saudi Arabia has decided not to renew its 80-year-old “petrodollar” agreement with the United States. This means that Saudi Arabia will now sell oil in multiple currencies, including the Chinese RMB, Euros, Yen, INR, and Yuan, instead of exclusively in US dollars.

What is a Petrodollar?

Petrodollars, which are not a currency but rather US dollars obtained in exchange for crude oil exports, emerged after the US abandoned the gold standard. According to Investopedia, the petrodollar system came about in the aftermath of the US going off the gold standard. Previously, under the Bretton Woods Agreement, the US had pegged its currency to gold at a rate of $35 per ounce.

Reason Behind the Deal

This agreement, brokered by Henry Kissinger in 1974, ensured that oil trade would be dominated by the US dollar. Saudi Arabia was persuaded to sign this deal with promises of US support against Iran and other regional threats. At the time, the US dollar had lost much of its credibility after President Richard Nixon suspended the Gold Standard in 1971. By creating the petro-dollar system, the US managed to maintain the dollar as the global reserve currency, facilitating economic growth through substantial debt accumulation.

US Losing its dominance

Now, without the Gold Standard or the petrodollar system, the US faces increased vulnerability. Debt becomes more costly, and the US can no longer print dollars as freely as before, putting the economy in a precarious position. 

The significance of Saudi Arabia not renewing the petrodollar agreement has multifaceted implications for global economic and geopolitical dynamics.

1. Impact on the U.S. Dollar: The petrodollar system has been crucial in maintaining the US dollar as the world’s reserve currency. With the end of this agreement, global demand for the US dollar could decrease, potentially weakening its value.

2. Geopolitical Realignment: The petrodollar agreement was not only an economic arrangement but also a geopolitical one, representing a broader alliance between the US and Saudi Arabia, which included military and political support from the US. The decision to end the agreement may indicate a shift in Saudi Arabia’s geopolitical alignments, potentially moving closer to global powers like China, India, and Russia, which advocate for reducing reliance on the US dollar in international trade.

3. Economic Impact: For the US, the end of the petrodollar agreement could lead to higher oil prices and inflation. Since oil is priced in dollars, a weaker dollar would make oil more expensive, increasing costs for businesses and consumers and potentially slowing down economic growth.

4. Financial Market Impact: US financial markets, which have benefited from global demand for US dollars and debt, could be negatively impacted. Reduced demand for US dollars might also lead to less demand for US government bonds, a cornerstone of the global financial system.

5. Shift in Global Power Dynamics: The petrodollar agreement has been a key element of US economic and geopolitical power. Its end could signal a shift in global power dynamics, allowing other countries and currencies to gain more influence.

6. Opportunity for Other Currencies: The conclusion of the petrodollar agreement presents an opportunity for other currencies, such as the Chinese yuan, INR, or the Russian ruble, to gain more prominence in global oil trade. This could accelerate the ongoing trend of de-dollarization in global trade.

Implications and Benefits on Indian Oil and Gas Companies

Here are a few implications:

Exchange Rate Risks: Companies may face new risks associated with currency fluctuations as oil transactions move away from the US dollar.
Oil Price Volatility: The end of the petrodollar could introduce new volatility in oil prices, affecting cost inputs and profit margins.
Strategic Realignments: Indian companies might need to reassess their strategic partnerships and alliances in response to shifting geopolitical alliances.
Financing Challenges: Access to capital and investment could be impacted as global financial systems adjust to the reduced role of the US dollar.
Regulatory Adjustments: New regulatory challenges or opportunities may arise as governments respond to changes in global oil trade practices.

Benefits

Improved Trade Balance: Trading in other currencies could potentially improve India’s trade balance with oil-producing nations.
Strategic Independence: Reduced reliance on the US dollar could give Indian companies more strategic independence in their international dealings.
No Conversion Cost: Indian companies would no longer need to convert INR to US dollars for oil transactions, potentially reducing conversion costs.

During Prime Minister Narendra Modi’s July 2023 visit to the UAE, the Central Bank of the UAE and the RBI signed two MoUs. One promoted the use of local currencies for cross-border transactions, and the other aimed to interlink payment systems. Following this, Indian Oil Corporation paid for one million barrels of crude oil from Abu Dhabi National Oil Company in rupees, and some Russian oil imports have also been settled in rupees.

Conclusion

In summary, the end of the petrodollar agreement is a significant event with potential economic, geopolitical, and financial market implications. It could lead to a weaker US dollar, higher oil prices, and a shift in global power dynamics. This change also presents an opportunity for emerging powers like India, suggesting that over the next 10-25 years, the influence of radical ideologies funded by the petrodollar may diminish.