Petrodollar

Updated on April 11, 2024
Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

Petrodollar Meaning

Petrodollar or petrocurrency refers to the US dollar traded for worldwide crude-oil exports. It facilitates the investment of export gains as the dollar is the world’s reserve currency. Moreover, the petrodollar history dates back to the US-Saudi agreement in the 1970s (including the recycling of additional oil profits), and the system is still strong defying the rumors of possible collapse.

Petrodollar

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Petrocurrency emanated from oil-supplying countries relies on the quantity and retail price of oil sold overseas, depending upon oil extraction. Furthermore, the oil-exporting nation may “recycle” the surplus oil proceeds back into their national economies or invest them into the American economy.

Key Takeaways

  • The petrodollar implicates the US dollar rendered to the oil-exporting nation for international trade.
  • It originated from the US-Saudi Arabia agreement in the 1970s, whereby the US provided weapons support to Saudi, and the latter started conducting its crude-oil sale in US dollars.
  • Though the Chinese yuan might be a strong replacement, the petrodollar collapse is a far less likely future event.
  • Petrodollar recycling indicates redirecting the excess US dollars back into the economy of oil-exporting countries, lending it to other nations, or investing in US economies.

Petrodollar System Explained

The petrodollar emerged after the eradication of the gold standard on a global scale. As it is denominated in US dollars, its buying power depends upon the US inflation rate and (if required) exchange rate in the worldwide stock market. Any financial or other elements equally influence the petrocurrency and US dollar, creating pertinent legislative and commercial consequences.

In the Bretton Woods Convention (1944), other nations signed to peg their currencies to the US dollar. Nevertheless, US President Richard Nixon withdrew the dollar from the gold standard on August 15, 1971, because of stagflation. In 1973, the Organization of the Petroleum Exporting Countries (OPEC) surged oil pricing within a brief timespan.

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Petrodollar Recycling

Petrodollar recycling denotes the outflows worldwide via the usage of oil receipts by the petroleum exporting countries. Moreover, it transpires through the absorption channel and the capital accountCapital AccountThe capital account refers to the general ledger that records the transactions related to owners funds, i.e. their contributions earnings earned by the business till date after reduction of any distributions such as dividends. It is reported in the balance sheet under the equity side as “shareholders’ equity.”read more channel. Therefore, both mediums are crucial to evaluate the boost in oil revenuesRevenuesRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more on worldwide imbalance.

The former utilizes petrocurrency to fund domestic investment and expenditure, therefore soaring the demand for importing products and utilities. While the latter uses petrocurrency unspent on imports to safeguard foreign assets held overseas, leading to the capital account discharge.

The US-Saudi Arabian Joint Commission on Economic Cooperation was instituted in 1979. It aimed to help Saudi evolution while recycling petrocurrency and enabling the flow of American machinery, goods, and utilities through excess oil earningsEarningsEarnings are usually defined as the net income of the company obtained after reducing the cost of sales, operating expenses, interest, and taxes from all the sales revenue for a specific time period. In the case of an individual, it comprises wages or salaries or other payments.read more.

Petrodollar Agreement 1973

The petrodollar history stems from the Soviet Union’s breakdown (1991), following which the US became the only superpower throughout the materialized unipolar world. Subsequently, the world observed several destabilizations and crises to sustain the leadership of the petrocurrency structure.

The term emerged in 1973 when the US agreed to offer armed protection to Saudi Arabia. It also provided weaponry and other military supplies in an agreement involving the overall sale of oil in US dollars. Moreover, Saudi Arabia would recycle the surplus dollars into the American economic system using US treasury billsTreasury BillsTreasury Bills (T-Bills) are investment vehicles that allow investors to lend money to the government.read more and bondsBondsBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period.read more.

By 1975, all OPEC members embraced the petrocurrency arrangement and consented to oil export in US dollars. As a result, the American currency now contributes to almost two-thirds of the international economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more. It is the reserve currency for most central banks worldwide since the US dollar is the chief currency needed for natural gas and oil trading.

Examples

To clarify, here are some instances of the petrodollar system to understand its history and modern context.

Example#1

If US president Joe Biden continues imposing targeted financial sanctions, Russia might consider moving away from the dollar-denominated oil-exporting agreements. Moreover, the Russian Deputy PM Alexander Novak said this shortly after the nation declared full removal of US dollar assets from the Russian national wealth fund.

Since 2014, the Russian economy has been functioning under global sanctions following the seizure of Crimea. Consequently, Rosneft (the nation’s biggest oil firm) fixed the euro as the default currency for new oil exports to safeguard it from the influence of US sanctions.

Example#2

The Kingdom of Saudi Arabia (KSA) plans to conduct future oil deals with China using the Chinese yuan. According to Dow Jones and Wall Street Journal, both countries are in talks to make a few yuan-priced oil deals. However, the shift to yuan will be painful and expensive for Saudi Arabia.

Being the largest crude oil importer worldwide (1.76 million barrels per day), China provides some attractive incentives to KSA. It has also explored relevant collaborations with Saudi Arabia offering support to build nuclear missiles and heavily investing in the KSA projects. Irrespective of this probable shift’s success, it is a major step in history toward the shift from the petrodollar.  

End Of Petrodollar

There are various things to consider while discussing petrodollar collapse. Moreover, the recent geopolitical instances in Ukraine have demonstrated a highly possible end to America’s monopoly in international affairs. By Quarter 1, 2020, just 46% of Russo-China bilateral dealings were conducted in US dollars. Global warming concerns and a shift toward increased sustainable energy diminish the oil demand. So, a new financial structureFinancial StructureThe financial structure refers to the sources of capital and the proportion of financing that comes from short term liabilities, short term debt, long term debt, and equity to fund the company's long term and short term working capital requirements.read more for foreign investmentsForeign InvestmentsForeign investment refers to domestic companies investing in foreign companies in order to gain a stake and actively participate in the day-to-day operations of the business, as well as for essential strategic expansion. For example, if an American company invests in an Indian company, it will be considered a foreign investment.read more avoiding petrocurrency and expensive externalities might be possible.

Nonetheless, almost 90% of foreign currency dealings are in US dollars. This accounts for 60% of forex reserves despite the country only contributing to nearly 20% of worldwide gross domestic productGross Domestic ProductGDP or Gross Domestic Product refers to the monetary measurement of the overall market value of the final output produced within a country over a period.read more (GDP).

The US utilizes the strength of petrocurrency for its international policy impositions because various countries don’t fight back owing to their anxiety over the petrodollar termination. Hence, the end of petrocurrency is a very improbable forthcoming event due to its liquidityLiquidityLiquidity is the ease of converting assets or securities into cash.read more and unavailability of another substitute.

Frequently Asked Questions (FAQs)

When Was the Petrodollar Created?

The petrodollar was created in the 1970s through a 6-page agreement signed by US President Richard Nixon and Saudi Prince Fand Ibn Abdel Aziz. While the US provided military supplies and equipment to the KSA, Saudi Arabia agreed to utilize US dollars for the oil agreements.

What Is Petrodollar System?

The petrodollar system implicates the US dollar globally accepted for oil exports. In other words, it is typically the international practice of trading oil for American dollars rather than another currency. The oil-importing nation (whichever it may be) must always pay the oil-extracting country in US dollars.

Why Is Petrodollar Important?

The petrodollar is the major revenue source for several OPEC members and other oil-exporting nations. Though there are rumors of its collapse, the relevance of the petrodollar is undeniable. Being the most extensively utilized currency, it smoothens the investment of export profits.

This has been a guide to Petrodollar and its Meaning. Here we describe the petrodollar system, its history, recycling, possible collapse, and examples. You can learn more from the following articles –