October 6, 2009 / 2:31 AM / 10 years ago

SNAP ANALYSIS: Ending dollar oil sales easy; pricing is hard

SINGAPORE (Reuters) - A report on Tuesday in the Independent newspaper revived the idea of ending a huge volume of trade of the world’s most liquid commodity — oil — in the U.S. dollar, a potentially major sign of the greenback’s fading status. Quoting unnamed sources, including Gulf Arab and Chinese banking sources, the paper reported that Gulf Arab states were in secret talks with Russia, China, Japan and France “to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf.”

That appeared to suggest the easier of two ways to break the oil/dollar link: ending the use of the dollar as the currency used to settle oil trades between countries or between companies, an important function but essentially a treasury operation, one that Iran, for instance, has already undertaken.

The much more difficult task would be to replace the currency in which oil is priced: the U.S. dollar, the currency that underpins benchmarks from New York to Dubai to Singapore, and which would require a massive effort to change.

In other words, if the plan materializes, it could be major news for forex markets by allowing oil exporters to more easily diversify their currency reserves and remove the need for importing nations to buy dollars to pay for their oil, but would appear unlikely to revolutionize oil trade.

The notion is hardly new and has been periodically raised, and frequently dismissed, during the dollar’s long slide this decade, particularly with increased discussion about a shift toward a new global reserve currency.

Although an increasing share of global commodity trade is being settled between counterparties in non-dollar currencies, that’s a far cry from changing the dollar-denominated markets that establish the underlying prices for those trades, even within the nine-year time frame that the paper cited.

* BENCHMARK BLOCKER

Beyond the strong political alliances between major Gulf exporters and the United States, there are deep logistical reasons to mitigate against a major shift in the basis currency for oil trade away from the U.S. dollar.

Despite the Gulf’s role as the swing oil supplier to the world — and China’s status as the fastest-growing consumer — the most liquid market for oil remains the New York Mercantile Exchange, followed by the London-based Brent contract.

Even the Oman crude oil futures contract launched two years ago in Dubai is traded in dollar terms.

Unless Gulf nations are prepared to remove restrictions on the free trade of their crude oil exports — allowing them to become benchmarks for the rest of the world, as some analysts have argued would be useful — it will be difficult for them to influence the basis currency for global oil.

Although commodity exchanges in both Japan and China offer local currency-based oil futures, they are ultimately linked back to regional benchmarks denominated in U.S. dollars.

* CONVERTIBILITY ISSUE

The fact that China’s yuan and many Gulf currencies are not fully convertible is also a significant obstacle to any effort to replace the dollar in global commodity pricing.

* IRAN EXAMPLE

Iran, the most virulently anti-dollar nation in the region, has notched up some modest success in reducing its involvement with the greenback.

Two years ago it asked its Asia customers to settle their oil trades in non-dollar currencies; after a few months of debate, most complied. But still Iran sets its export prices based on a formula linked to dollar-denominated benchmark crudes.

Iran has pushed for the Organization of the Petroleum Exporting Countries to switch from the dollar when calculating international oil prices, though it has so far received little support for the initiative.

Reporting by Jonathan Leff; Editing by Clarence Fernandez

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