Dennis Kissler, Contributing Editor

Recent reporting that Saudi Arabia would abandon the 50-year “petrodollar” agreement with the U.S. went viral on social media, though some have since called it “fake” news. Still, it’s an idea worth examining and, more importantly, what losing close oil-market ties between the U.S. and Saudi Arabia could mean for the global oil market and the U.S. currency.

In the mid-to-late 1970s, Saudi Arabia and the U.S. agreed to work together to stabilize oil prices. Remember, during that time, the U.S. had incurred gasoline shortages and higher priced crude due to embargoes.

As a result, the U.S. was looking for oil prices to stabilize. Meanwhile, the Saudis, who now had vast oil-producing assets, were looking for stable military protection and a safe haven to park their cash. And so, Saudi Arabia agreed that oil would be priced in U.S. dollars. In return, the U.S. agreed to add a larger presence of military force protecting Saudi Arabia.

Fast forward, around 50 years later: In January 2023, well before the most recent story went viral, Saudi Arabia indicated that it was open to trading in other currencies. It seems that Saudi has looked at the situation and is evaluating where they’re parking their own money. In the 1970s, they wanted safety, so their needs were a good match with the U.S.’

 However, recently Saudi Arabia has been hearing a lot of a lot of noise from parts of Asia.

This noise all goes back to manufacturing. In the 1970s, the U.S. was the manufacturing powerhouse of the world by far. Now, China, India and other Asian countries are becoming manufacturing powerhouses and thus large oil consumers. When you add in Russia, which also has been gaining in manufacturing and commerce and is a major producer of oil, the result is that all of these countries (and especially China) can possibly help diversify Saudi Arabia’s economy.

End of an era?

For the U.S. and the oil market in general, the potential of the U.S. losing close ties with Saudi is concerning from a longer-term perspective. If the price of oil stops being traded in U.S. dollars and instead starts being trading in yuan, rubles or a new BRICS currency, that could destabilize the oil market. Now, I don’t say this to cause a panic, as I don’t think the shift will happen today or tomorrow. However, such an event could happen if multiple variables come together—for instance, if the U.S. gets another credit downgrade.

So, why the potential destabilization? It’s important to remember that there are worldwide service companies that base their payments in U.S. dollars. If they have to switch into having balances in multiple currencies, it would likely cause some instability, at least at the beginning. In fact, this potential instability is one of the reasons why I think the U.S. needs to be proactive in taking steps to keep close oil ties with Saudi Arabia and protect the petrodollar.

Potential impacts

Another reason I think the U.S. needs to be proactive is the potential impact to the dollar’s status as the world’s reserve currency. If substantial amounts of oil go on the global market and are priced—that is, auctioned—in currencies other than the U.S. dollar, it could leave the dollar vulnerable to wider pricing swings. While the near-term effects should be mild, when this occurs over the longer term and in bigger volumes, it could give other countries the opportunity to strengthen their valuation versus the U.S. dollar. If that happens, it could pull investment dollars away from the U.S.

Moreover, if the worldwide service companies that base their payments in U.S. dollars switch currencies, a lot of the dollars that are floating around the globe could come back to the U.S. If that happens, it would most likely devalue the dollar and reignite inflation in the U.S., so that’s another factor to consider.

Still a lot of “ifs” at play

Now, will all this happen? Again, there are a lot of what “ifs” here, so nothing is certain.

After all, foregoing the petrodollar has potential downside for Saudi Arabia, too, even as trading oil in other currencies could possibly help diversify Saudi’s economy. Keep in mind that the U.S. is the largest oil producer and still the largest oil consumer, so for Saudi to step out of that box could also trigger policy changes by the U.S. For instance, while U.S. refineries mostly rely on Middle East oil at this time, the U.S. could become more self-reliant, which could cause a backlash financially to Saudi.

All that said, oil sales out of the Middle East likely will still be a major factor for the U.S. for the next 20 years, so it’s important to protect the petrodollar. Yes, there are private sales in which oil is being sold in other currencies, but in those cases, Saudi isn’t setting it on the global market and is very sensitive to not doing so.

The bottom line

The fact that the recent story reporting the end of the petrodollar went viral highlights the sensitivity around currency shifts and the importance of avoiding devaluation. If we get a looser U.S. dollar due to our current rate of printing money, it could lead to inflation and devaluation. A lot of the money sent to Ukraine, although it was for military aid, could eventually make its way back to the U.S., which is also inflationary. Look at the price of gold: it continues to trade radically, and I’m not sure we’ll see the high in that market until the U.S. stabilizes its deficit situation.

And so, while things may seem a little uneasy, nothing pertinent is likely to happen in the near term. But it is something the U.S. needs to address. I think the U.S. is going to stay the biggest oil producer and consumer on the world stage, but other countries, especially India and parts of Asia, are catching up quickly. If the U.S. keeps sending our manufacturing overseas without balancing it by producing things domestically, it will eventually work against us.