Will OPEC Dump the Dollar?

The fall of the U.S. dollar—and the domestic unhappiness this creates—is causing oil-producing nations to reassess links to the greenback

by Stanley Reed

The dominant theme that emerged from the cacophonous OPEC summit that concluded in Riyadh on Nov. 18 was countries that have amassed huge piles of dollars from selling oil don't like seeing the value of their currency reserves eroded. While the host Saudis urged restraint lest the dollar fall even more, Iranian President Mahmoud Ahmedinejad scorned the greenback as a "worthless piece of paper."

Iran is pushing OPEC to shift away from pricing oil in dollars and instead to a basket of currencies that could include the euro. The Islamic Republic is already requiring its customers to pay in euros or yen, partly to avoid a tightening financial squeeze orchestrated by the U.S. But this is largely a symbolic gesture because the price of its oil is still based on dollar benchmarks.

Iran and Venezuela managed to persuade Saudi Arabia to agree to discuss the swooning buck at the next OPEC meeting in Abu Dhabi in December, but engineering a shift to an oil pricing regime based on the euro or another currency anytime soon is far-fetched. "The obstacles are overwhelming," says Edward Morse, energy economist at Lehman Bros. (LEH) in New York. He notes that virtually all oil sold today is based on three benchmarks: West Texas Intermediate traded on the NYMEX; Brent traded on the ICE in London; and Middle East Dubai/Oman crudes as assessed by Platts or settled on the Dubai Mercantile Exchange. All are priced in dollars.

Eroding Power of Currencies

"It is hard to imagine how an exporter and importer of crude oil could agree on mutual terms without pricing off one of these," Morse says. Besides, he adds, producers should know "it is an illusion to think that you are going to have higher real prices globally by switching currencies." Prices, he says, already "basically reflect fair market value."

At the same time, the falling dollar could bring about potentially destabilizing changes to the currencies of the Gulf Cooperation Council countries, which include Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, and Oman. Most are now tied to the dollar. But the populations of the big Gulf producers are grumbling about the eroding purchasing power of their currencies, which have taken a roughly 9% hit against the euro since mid-August, despite rising oil prices and revenues.

Now, even hitherto reluctant governments such as Saudi Arabia's are feeling pressure to take steps to make sure their citizens feel richer, not poorer. "Having the riyal brought down with the dollar reduces the buying power of the average guy," says Brad Bourland, chief of research at Jadwa Investment, a Riyadh-based financial house. "Vacations in Europe and the U.K. seem very expensive."

Losing Confidence in the Dollar

If the dollar continues to fall against the euro—the most closely watched alternative to the dollar—some of the Gulf countries may follow the example of Kuwait, which shifted to a basket of currencies in May, and adjust their dollar-linked exchange rates accordingly. Kuwait has not disclosed the makeup of its basket, but it is thought to be about 65% to 70% dollar-based, along with 15% to 20% euros and a dash of yen, sterling, and other currencies. The dinar has risen about 5% against the dollar since the change, to .2762 dinars per dollar.

A revaluation of one or more of the Gulf currencies, which most analysts think will be initially in the range of a 3% to 5% appreciation, would still be a concern to U.S. policymakers because it risks looking like a vote of no confidence from some of the biggest holders of greenbacks. Heavy selling of dollars and buying of Gulf currencies such as the Saudi riyal may have contributed to the 1% fall of the dollar to a record low of 1.478 dollars to the euro on Nov. 20.