Oil has been priced in dollars for decades, one of the few predictable relationships in a commodity market that can be very volatile. But there’s a shift under way in some countries that is reducing the dollar’s dominance.
The most prominent country that has shifted sales away from the dollar is Russia, which accounts for about 10% of oil production, according to J.P.Morgan analyst Natasha Kaneva. Russian oil no longer flows to Europe or the U.S., because of sanctions related to Russia’s invasion of Ukraine, and an increasing amount of its oil has gone to India and China. Other countries that have been sanctioned by the U.S. have also shifted the currencies they use. Venezuela, which has the most oil reserves in the world, started using the Chinese yuan or the euro for its oil trades following the imposition of U.S. sanctions. Overall, about 20% of the world’s oil is now being sold at discounted prices because of sanctions, Kaneva estimates. Much of that trade has moved away from the dollar, or at least has the potential to do so.
The shift is important for several reasons. Oil has long traded in an inverse relationship to the dollar. When the dollar gets stronger, oil tends to get weaker, on the margin. But that relationship has begun to wane. Kaneva believes the move away from the dollar began around 2014. She tracked the impact of changes in the value of the dollar against changes in oil prices. From 2005 to 2013, a 1% appreciation of the U.S. trade-weighted dollar reduced the price of international oil by about 3%, but it only led to a 0.2% drop between 2014 and 2022. That change in relative sensitivities may mean that oil will not benefit much from a recent decline in the value of the dollar. Nonetheless, Kaneva expects oil prices to rise in the third quarter as demand outpaces supply.
The decline of the dollar does not appear to mean a new currency will become the clear leader in the oil trade. No one alternative currency appears to be taking its place. Instead, prices are being denominated in several local currencies, sometimes in surprising ways. For instance, Indian refiners have begun paying for Russian oil in dirhams, the currency of the United Arab Emirates. The value of the dirham is pegged to the dollar, which offers some stability to traders while allowing Russia to divert money away from dollars.
The change in trading patterns may elevate some developing countries, Kaneva predicts.
“This de-dollarization trend in the commodity trade is a boon for the countries like India, China, Brazil, Thailand and Indonesia, which can now not only buy oil at a discount, but pay for it with their own local currencies,” she wrote. “This reduces the need for precautionary reserves of U.S. dollars, U.S. Treasuries and oil, which in turn might free capital to be deployed in growth-boosting domestic projects.”
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All that said, it’s still difficult to move away from the dollar—and by some measures the dollar is only getting more important. As of the end of the first quarter, 55% of the world’s reserves were still in the greenback, up from 54% at the end of last year, according to the International Monetary Fund.
For one thing, it can be difficult for countries to trade in alternative currencies if they don’t have robust two-way trade. Russia reportedly has built up a large surplus of rupees that it currently has no use for, and that Russian companies can’t easily repatriate into Russia, for instance.
Some commentators argue that the reports of the dollar’s demise are premature.
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“We do not see another currency with the liquidity and widespread acceptance to knock the dollar off its perch,” wrote Wells Fargo Investment Institute strategist Scott Wren last month.
Write to Avi Salzman at [email protected]
