Trump’s move to control Venezuelan oil supply might have a petrodollar angle. Here is how

Access to these reserves would help the US cement its status as the dominant producer of crude globally, and help it gain a vital geostrategic advantage over the likes of China and Russia. Additionally, Washington might be hoping to bolster the fortunes of the ‘petrodollar’, which had been losing some of its sheen over the past few years. We explain.

What are petrodollars?

Simply put, petrodollars are US dollars earned by oil-exporting countries as revenue for their crude oil exports. With major oil producers led by Saudi Arabia pricing their oil in dollars from the 1970s, the greenback became the primary currency for oil trade all over the world.

The petrodollar has played a key role in helping ensure that the dollar retains its status as the world’s reserve currency. Petrodollars are essentially a notional currency and do not amount to a formal trading system.

How did the system of pricing oil in dollars come about?

The 1944 Bretton Woods Conference replaced the gold standard, in which the world’s currencies were pegged to a fixed quantity of gold, and set the dollar as the world’s primary reserve currency, pegged to gold at $35/oz. Other nations thus determined their exchange rates with respect to the dollar. The US was estimated to own 70% of global gold reserves by 1947, according to IMF estimates.

Faced with dwindling gold reserves, this system collapsed in 1971, and President Richard Nixon ended dollar convertibility. The dollar thus became a fiat currency, or legally issued tender by the government.

This move would have implications during the 1973 oil crisis, when the Organisation of Petroleum Exporting Countries (OPEC) announced a trade embargo against countries that had supported Israel during the Yom Kippur War that year. Faced with a 300% increase in oil prices, the US negotiated a deal with Saudi Arabia, the dominant OPEC member, the following year.

In addition to a formal agreement for cooperation in trade and industrial needs, an informal understanding was widely reported to have been reached: The US agreed to offer military protection for Saudi Arabia’s oil fields, provided:

• The kingdom priced its oil exports exclusively in dollars
• Its massive oil revenue surpluses would be invested in the US financial system

Following Saudi Arabia’s lead, most other major suppliers also priced oil in dollars. This meant that oil-importing countries, including India, were forced to continuously purchase dollars in order to buy crude. This petrodollar arrangement created unceasing demand for the dollar, helping boost Washington’s economic and strategic might.

Petrodollar and US fortunes: Times they are a-changin’

Given that the US was a large importer of crude oil until relatively recently, the petrodollar arrangement helped oil-exporting countries build large trade surpluses with the US, most of which were ploughed into US Treasury securities, stocks, and other dollar-denominated assets.

The standardisation of oil trade in dollars and the reinvestment of these surpluses into US markets helped the robust US economy strengthen its hegemony and exert consequential leverage over countries involved in oil trade—exporters as well as importers. With high dollar-dependency globally, the US enjoys significant influence over global energy security and trade dynamics.

But over the past few years, the petrodollar arrangement has weakened to some extent, even as the global oil trade continues to be largely dollar-denominated. The past couple of decades, particularly, have seen some tectonic shifts in the oil market, which has had a notable bearing on the petrodollar. Other factors, including the rise of emerging economies—most notably China—and the US’s sanctions on some large oil-producing countries, have also had an impact.

With its shale revolution starting in the first decade of this century, the US has been able to boost its domestic oil output, and is now the world’s largest oil producer and a net exporter of the commodity, a far cry from being a top oil importer in the preceding decades. Thus, the US’s position in the very system it helped to create has shifted from net importer to net exporter, potentially reducing its dependence on this system. Meanwhile, some of the large oil producers that were recycling petrodollars by investing in US markets are now increasingly using their surpluses to maintain or better their own fiscal health.

Over the last two decades, the US hegemony has been increasingly challenged by China. Trump’s willingness to levy tariffs and sanctions at whim against perceived rivals also poses a threat to the USD’s status as the world’s reserve currency, and thus the relevance of the petrodollar. Accompanying this has been a growing effort by countries in the Global South to unite, and a larger push for de-dollarisation.

Then there are the geopolitical and strategic fault lines in Washington’s relationships with major oil producers like Iran and Russia, and even Venezuela. Oil from these countries is subject to various US sanctions and restrictions, essentially barring the trade of such oil in dollars. As a result, most of the sanctioned or restricted oil is paid for by its importers—predominantly China—in other currencies. While the dollar remains the dominant currency in oil trade, the share of other currencies has been rising over the past few years.

However, any shift away from the dollar’s dominance would likely be protracted given how it is entrenched in the global economy. The greenback remains the most preferred currency in oil trade, as well as a reserve currency, according to the IMF. Trump wants the dollar’s dominance to be maintained, and exercising control of the world’s largest oil reserves can certainly help.

Swareena Singh is an intern with The Indian Express.