Oil and gas in the capitals

Since the dollar was decoupled from gold in 1971, oil has underpinned its
international position. Since oil is paid for in dollars, oil demand means demand for dollars. This is essential to United States economic power, the ability to consistently run current account deficits, and to use the dollar as a political weapon. The dollar hegemony in oil trading is under pressure from China and the U.S., itself.

Unintended consequences. As China launches yuan oil trading, the U.S., through sanctions policies, actively discourages dollar oil trading. By forbidding dollar transactions with major oil exporters, such as Iran and Venezuela, and by imposing trade sanctions on others, such as Russia, it encourages new solutions. Although the intention is to reduce oil export volumes and revenues of the countries concerned, the outcome is the emergence of oil trading circuits that bypass U.S. banks and evade the U.S. dollar.

In the longer run, it undermines the U.S. dollar’s international position. During summer 2019, Russia offered to cooperate with the EU in skirting U.S. sanctions on Iran. The U.S. response was that any non-compliance with sanctions, on Iran or any other country, would mean exclusion from the dollar system. Weaponizing the dollar potentially makes a double-edged sword.

Alternatives. U.S. sanctions encourage other countries to price and trade oil in other currencies, such as the yuan or euro. Circumventing U.S. sanctions reduces dollar demand. Secondary sanctions may prompt these figures to rise. With selective tariffs and restrictive trade measures, the U.S. has chosen conflict with countries that, together, account for a good part of the world economy and global oil demand.

Through selective sanctions against targeted countries and secondary sanctions on others, the U.S. has opened a Pandora’s Box of escalating, reciprocally hostile measures. Secondary sanctions use commerce as a coercive weapon; they risk backfiring. 

The Shanghai Oil Futures Exchange, launched in March 2018, is a first, so far, modest challenge to dollar oil price formation and trading. By summer 2019, China’s yuan oil transactions accounted for 12% of international trade. Russia benefits from a facility to exchange yuan into gold

The EU is still the largest oil buyer globally and the largest source of oil-based dollar demand. Europe has been unable to save the JCPOA (Joint Comprehensive Plan of Action) agreement with Iran. In 2018–2019, U.S. escalation of the conflict with Iran has met a meek European response. INSTEX, a special trading body to facilitate Iranian purchases of food and medicine, is of minor help. Iran’s hope, that INSTEX would allow sales of large volumes of oil, is stranded on Europe’s fear of U.S. retaliation. Russia has offered to join INSTEX, proposing to include oil, dodging U.S. sanctions.

In the meantime, China, India, Malaysia and Turkey defy U.S. sanctions and continue buying Iranian oil. Russia is willing to assist by processing payments. The U.S. objective is to halt all Iranian oil exports. By September 2019, the U.S. had not fully succeeded in terminating Iranian oil exports; the issue is to how extensively it would apply secondary sanctions on China, India, Russia and Turkey. Europe is in a squeeze.

The willingness of foreigners to use their savings to purchase U.S. debt is contingent on the U.S. dollar’s international reserve currency status. Foreign financing has enabled the growth of defense budgets and military expenditures abroad. Until 2018, practically all international oil transactions were settled in U.S. dollars. Consequently, the U.S. needs the EU to continue buying oil in dollars.

In 2017, the U.S. current account deficit was $449 billion; the EU oil and product import bill was €191 billion, corresponding to $216 billion. If the amount was entirely invoiced and paid for in U.S. dollars, the value of EU imports corresponded to about one half of the U.S. current account deficit. From this perspective, the U.S. depends on the European Union for sustaining international dollar demand and financing its deficits.

Insofar as Europe should not succeed in establishing an oil trade facility with Iran, Russia might act as an intermediary. Reasonably, this trade should not be conducted in U.S. dollars, but in euros. This would step up the de-dollarization of international trade.

The U.S. withdrawal from the JCPOA, and imposition of secondary sanctions, harms European economic interests and shows their limited sovereignty in relation to the U.S.

Euro usage. The EU aims to promote international use of the euro. Most EU energy imports are not contracted in euros, despite originating in Russia, the Middle East, North Africa and Norway. Paying for oil in U.S. dollars implies a currency risk, in addition to the oil price risk, and an additional hedging cost.

Euro trading in oil is a possible starter that would be welcomed by many energy exporters, not the least Russia, strengthening the international position of the euro, but risking conflict with the U.S. Time may be ripe for a European oil futures exchange, trading in euros, but would the EU do it?

Short-circuiting EU hesitations, in August 2019, Rosneft announced it would invoice oil product exports in euros, instead of U.S. dollars. The move is motivated by Russian fears of new sanctions by the U.S. Since 2014, Rosneft has been on a U.S. sanctions list. The risk of unpredictable U.S. measures also might incite Russia to invoice oil exports in euros. This could further erode the oil-based dollar hegemony, strengthening demand for the euro.