Commentary: The PetroDollar Debate

Now that the furor over the US housing crisis/credit crunch has begun to subside in forex markets, investors have turned their attention to what is perhaps the second biggest threat to the Dollar’s long term health: the PetroDollar phenomenon.  In short, the price oil is denominated in Dollars and many oil-exporting nations peg their currencies to the USD. Having found themselves awash in cash, such nations are beginning to ponder greater financial independence from the declining Dollar.

The anecdotal evidence for the declining importance of the Dollar among oil-exporting countries could not be stronger. Last week, the Forex Blog reported two developments. First, OPEC is considering altering the way oil contracts are settled, by pricing oil in a basket of currencies rather than in USD.  Next, the members of the Gulf Coast Council are considering de-pegging their currencies from the Dollar, due to rising inflation and the increasing opportunity cost of owning Dollar-denominated assets.

Actual data, on the other hand, suggests that OPEC may be moving in the opposite direction, towards a greater dependence on the Dollar.  The US remains the most popular destination for petrodollar investments, attracting 55% of all such investment capital. Europe comes in at a distant second, attracting just 18%. Plus, in the last year, oil money has been used to make several widely-publicized investments in American investment groups, including a recent $7.5 Billion investment in Citigroup by the Abu Dhabi Investment Authority.

The evidence is certainly nuanced. In all likelihood, OPEC will make good on Iran's failed attempt to sell oil denominated in Euros by linking oil to a basket of currencies.  In their own words, “oil is being sold in a currency whose value was eroding by the day.”  At the same time, the US is still the home of the world’s best capital markets, from the standpoint of stability and risk. Thus, while it’s possible that some or all of the members of the GCC will de-peg their currencies from the Dollar, any relative decrease in Dollar-denominated investments is likely to be passive, rather than active.