Petrodollar call off: Dedollarization starts now?

Petrodollarcall off: The US-Saudi Arabia petrodollar agreement has come to an end after 50 years. This historic agreement, established on June 8, 1974, enabled the exchange of US Dollars for crude oil exports, reinforcing the Dollar's dominance.

In recent years, the global oil trade has been undergoing significant changes, with a notable shift away from transactions exclusively conducted in US Dollars. This trend, often referred to as de-dollarization, is driven by geopolitical dynamics, economic strategies, and the search for stability amidst global uncertainties.

Countries like India are increasingly exploring alternatives to the Dollar, opting to trade in currencies such as the Rupee, Yuan, and Dirham. Such moves not only reflect economic pragmatism but also signal potential shifts in global power dynamics.

In an EXCLUSIVE interaction with Republic Business, Prashant Vashisht, Senior Vice President, ICRA delved into the implications of these changes, particularly focusing on the potential impacts on India's oil trade and oil diplomacy, as well as the broader effects on the global economic order.

Edited excerpts:

Q: Could you please clear the fog around the petrodollar deal?

In 2023, about 20 per cent of oil was traded in currencies other than the Dollar. If the petrodollar deal is not renewed, several impacts may occur, although they may not be immediate. Over the long run, there are a few key things to consider. Firstly, oil companies will need to rethink or redesign their forex hedging strategies, which are currently almost completely Dollar-based.

They will need to rethink their strategies accordingly. When the Dollar strengthens, it can have a dampening effect on global oil demand. Even if the oil price remains the same, a sharp appreciation of the Dollar makes crude oil more expensive in local currencies, as countries convert their currencies into Dollars for purchases. This increasing cost can dampen demand, as commodities become progressively more expensive.

To the extent that there is elasticity of demand at higher crude prices, there will be an impact due to the shrinking value of the Dollar. This aspect will change. Additionally, currently, all products, etc., are Dollar-denominated, as oil and gas companies primarily use FOB pricing at the Arab Gulf and then convert it into Rupees using the Dollar exchange rate. Essentially, these are Rupee balance sheets, but they are practically Dollar-denominated.

Additionally, the fluctuations in the USD-INR exchange rate would reduce as trade shifts away from the dollar. For example, whenever there is a large requirement of dollars, it would lead to a spike in the exchange rate. However, as trade shifts away from the dollar, these spikes would reduce and become less pronounced.  

So, all that will have to change. The third impact, which isn't specifically related to the oil and gas industry, but is significant, is that as the Dollar loses its dominance, gold and other commodities may become more expensive. This is because many central banks are investing in gold, as we've seen globally. If this trend continues, the impact could become more pronounced. Additionally, as you mentioned earlier, in the calendar year 2023, oil was traded not only in Dollars but also in other currencies.

Q: Could you explain how trading in other currencies for oil has emerged in recent years?

Last year, trading in other currencies increased for several reasons, including the Ukraine-Russia conflict and efforts by many countries to move away from the dollar. For example, India began trading of crude oil in yuan, rubles, and UAE dirhams. This shift gained more momentum after the conflict in 2022. While I'm not certain about the proportions before the Russia-Ukraine conflict, it is clear that a significant portion of trading in 2023 involved other currencies as well.

Q: Do you think moving away from Dollar-denominated transactions, which have been standard for many years, is feasible? Can this shift realistically happen if a treaty expires, or is there a rational basis for such a move to other currencies?

The rationale for moving away from dollar-denominated transactions is more geopolitical than purely economic, in my view—at least from the perspective of an oil and gas industry observer. Even when transactions are priced in dollars, the actual dollars aren't always exchanged; instead, countries might convert the dollars into their own currencies as needed. By pegging prices to the dollar but not necessarily transacting in dollars, the dollar's role in the system diminishes. Additionally, many countries can conduct a significant portion of their bilateral trade in their own currencies, reducing the physical requirement of the dollar.

Historically, the dominance of the dollar in global trade began in 1974, when the dollar became the primary currency for one of the world's largest traded commodities.

Q: Since the Rupee isn't widely accepted internationally, don't you think that trading in different currencies could lead to some complications?

You're right—it won't happen overnight. This process could take years or even decades to fully develop. It will gradually gather pace rather than occur suddenly. There could indeed be bilateral imbalances, like Russia, which now holds a significant amount of Indian Rupees and is uncertain about how to use them. Our trade balance with Russia, like with other countries, is very one-sided. However, as one of the largest economies in the world with significant exports, India could potentially de-dollarise to some extent.

There are also discussions about other initiatives, like the BRICS currency etc. It's unclear how these will actually play out. Nonetheless, 20% of oil was traded in other currencies last year, which would have been unthinkable a few years ago.

For instance, trading in currencies like the Yuan or Dirham can bypass the Dollar, allowing these transactions to proceed independently.

Q: Given your expertise in this sector, have you observed any similar dedollarization efforts between countries in the past?

Not for oil trade.  In India, we haven't really witnessed significant changes in this regard, making it a notable development. Last year, discussions around trading of crude oil in Yuan, rubles or Dirhams emerged. It's important to note that the Dirham is pegged to the Dollar, and its value isn't freely floating; it maintains a fixed rate, such as 3.67. This implies that transactions are conducted in Dollars, but payments are made in Dirhams.

This setup can potentially bypass the need for buying large amounts of Dollars, which might otherwise strengthen the Dollar's value against other currencies. When transactions are conducted in alternative currencies, the direct demand for Dollars decreases, possibly affecting the Dollar's strength.

However, there is still uncertainty about the future of these deals. Speculations and media reports are circulating, and if a dedollarization trend materialises, it could have significant implications for India's oil trade and oil diplomacy. This development could potentially be advantageous for India, reducing its dependence on the Dollar and possibly enhancing its influence in global oil markets.

Q: If this materialises and de-Dollarization occurs, how could it impact India's oil trade and oil diplomacy? Would such a shift be advantageous for India?

The Indian Rupee's value can affect how expensive it is for countries to buy crude oil, especially those whose local currency isn't the Dollar. When India conducts transactions in Rupees or another local currency, it reduces dependence on the Dollar. This could be beneficial for oil trade because paying in Rupees might encourage other parties to invest in or purchase Indian products.

An economy the size of India cannot be ignored—everyone wants to engage with India. This is why when India expresses a desire to make payments in rupees, other countries may have to adjust, as there is increasing interest in trading in local currencies. In the global context, as the demand for oil and gas is expected to taper off over time due to the ongoing energy transition, countries like China, Saudi Arabia, and others are investing in stakes in refineries worldwide to secure some level of demand in the future. While these changes might not significantly impact in the next 1 to 2 years, they are likely to have an effect insay 7 to 8 years.

When India begins to conduct transactions in Rupees, other companies and countries may also need to consider accommodating these transactions. This is especially pertinent given that India is a major buyer, and as global demand for commodities like oil diminishes, these countries will likely be keen to engage in trade with India in order to sell their products in this scenario of decreasing demand.

Therefore, it's not unreasonable to view this as the beginning of de-dollarization, particularly in the context of the world's most traded commodity. If this trend continues, it might not pose a loss for India, even if significant changes occur.