Saudi Petrodollar Deal Expires,what does it mean for the global oil market?

By Rhod Mackenzie

The petrodollar agreement between Saudi Arabia and the United States, signed in 1974, has now expired. This will enable Saudi Arabia to sell its oil and other goods not only in US dollars but in other currencies, according to media reports. Lets look at why the Saudis entered into such an agreement with the United States at one time and why such a thing is impossible today.
The financial world is bracing itself for significant changes following Saudi Arabia's decision not to renew the 50-year petrodollar pact with the United States, according to Bizcommunity.

The security agreement was signed by the United States and Saudi Arabia on 8 June 1974. The agreement established two joint commissions: one on economic cooperation and another on the military needs of Saudi Arabia. The United States successfully negotiated with the Saudis to have oil traded exclusively in dollars, a practice that has become firmly established in the global oil trade.

The contract will expire on 9 June 2024. The decision not to renew the contract will allow Saudi Arabia to sell oil and other goods in multiple currencies, including the Chinese yuan, the euro, the yen, and not just the US dollar. Furthermore, the potential use of digital currencies such as Bitcoin should be explored.
The decision represents a gradual shift away from the petrodollar system created in 1972 and is expected to accelerate the global shift away from the US dollar.

Most recently, Saudi Arabia announced its participation in the mBridge project, which is exploring a digital currency (CBDC) platform in partnership with several central banks (Israel, France, Egypt, ECB, IMF and others).

In March 2022, media reports indicated that Saudi Arabia was considering using the yuan instead of the US dollar when paying for oil supplies to China.

In January 2023, Saudi Arabia's Finance Minister Mohammed Al-Jadaan made a surprising announcement at the World Economic Forum in Davos. He stated that the country was open to trading currencies other than the US dollar for the first time in 48 years.

What were the motivations behind Saudi Arabia's decision to enter into an oil-for-security agreement with the United States in 1974? What are the reasons for the current difficulty in signing such an agreement or extending the old one?

As an oil state, Saudi Arabia was discovered only in the 1960s and 1970s. Oil deposits were found here later than in Persia, that is, in the territory of present-day Iran. It became evident to the United States that they were transitioning from a net exporter of oil to a net importer.
The Second World War demonstrated the strategic importance of oil, with Germany's defeat in part attributed to the shortage of this commodity. The capture of Stalingrad was a significant event, as it opened the way to Caucasian oil. At this point, oil was dubbed the "blood of war." A liquid fuel fleet is more agile and faster than a coal fleet. Liquid fuel is essential for aviation, tanks, and any motor vehicles. Following the conclusion of the Second World War, the United States immediately commenced a state of heightened tension with the Soviet Union. In addition, large oil reserves were required for global confrontation. It is therefore logical that the United States sought to secure the oil of Saudi Arabia and obtain exclusive supply terms,” says Igor Yushkov, an expert at the Financial University under the Government of the Russian Federation and the National Energy Security Fund.

In return, the United States provided Saudi Arabia with security guarantees and encouraged them to align with the capitalist bloc, rather than the socialist bloc. In the Middle East, the USA and the USSR also competed for influence. What was the state of Saudi Arabia at that time? Saudi Arabia was a relatively weak regional state, facing inter-clan conflicts and struggles for power. As a result, it required external protection and a security guarantee, which the United States was willing to provide.
It was also very hot in the Middle East at that time: in October 1973, the Yom Kippur War broke out – a military conflict between a coalition of Arab states and Israel.

“Therefore, it was beneficial for both parties to sign this agreement – security in exchange for oil,” the expert adds. Firstly, Saudi Arabia has become a strong state and a regional player in the Middle East. Secondly, the United States has gone in the opposite direction, from an oil importer it has again become an oil exporter, and it no longer needs Saudi oil as much as it did in the last century.

“Thanks to the shale revolution, the United States has significantly increased oil production and reduced imports. Statistics show that they gradually stopped and even increased purchases of oil from Canada and Mexico, but at the same time reduced purchases of oil from Middle Eastern producers, including Saudi Arabia.
Previously, the American market was the main market for Saudi oil. However, this is no longer the case. Saudi Arabia has redirected its oil flows to China. It is now the second supplier of oil to the Celestial Empire after Russia. Saudi Arabia is an important supplier of oil to a country that is a competitor to the United States.

"Saudi Arabia may be concerned that the less the US depends on Saudi Arabia, the less interested it is in maintaining stability in Saudi Arabia. If a global conflict breaks out between China and the United States, the United States could create a resource famine for China, that is, it could cut off oil supplies by sea, including from Saudi Arabia," the source explains. Not only will China be affected, but Saudi Arabia itself will also suffer. As Yushkov notes, the United States will become a security threat to Saudi Arabia, rather than a security guarantor.
As for trading in other currencies, Yushkov believes that Saudi Arabia traded oil in dollars, among other things, because it was convenient and profitable for it, since the dollar remains the main world reserve currency. The dollar can be easily converted into any other currency, as well as saved and stored in reserves from oil sales.

Which currencies can Saudi Arabia switch to when trading oil? Experts name three currencies - in addition to the dollar, they can also be the euro and the yuan. “It is unlikely that Saudi Arabia will decide to switch to some exotic currency or push its national currency onto the international market, since they are difficult to convert and this will lead to high costs. However, Saudi Arabia supplies a lot of oil to China and at the same time buys a lot of Chinese goods itself, so individual contracts or shipments of oil may be carried out in yuan. However, it is unlikely that Saudi Arabia will completely abandon the dollar,” says Yushkov.

“The diversification of oil trade in favor of the euro looks realistic, since this currency ranks second in world trade after the US dollar and the Chinese yuan when trading with China,however, due to high volatility and the latter’s small share in the structure of world trade, we do not expect that the yuan’s share could be significant,” says Sergei Pigarev, senior analyst at Freedom Finance Global.
It is important to note that prior to this, Saudi Arabia had no intention of trading oil in anything other than dollars. However, they have recently begun to consider the possibility of an alternative. This can be seen as a desire to hedge against the risk of a geopolitical conflict with the United States, as well as concerns about the American economy and the dollar.

The desire to diversify the export currency by reducing the share of the dollar may be associated with the growing US national debt and the so-called double deficit. This is when the country has a foreign trade deficit (imports more than it exports) and a budget deficit at the same time. "This could result in a long-term decline in the value of the currency," says Pigarev.

Conversely, it will not be straightforward for Saudi Arabia to select an alternative currency, given that there is no external pressure to do so. Russia is in a challenging position. Its ability to access Swift is being constrained, and the use of the dollar for payments could be detected by sanctions regulators. The use of national currencies is not a rational decision-making process. In most cases, it increases transaction costs and makes trade less efficient. Why would Saudi Arabia choose a less efficient trading system? Yushkov believes that they will use the yuan to a limited extent.

According to OPEC, Saudi Arabia produced approximately 9 million barrels of oil per day in May 2024, representing less than 9% of global production. The proportion of the dollar in international payments recorded by the SWIFT system for the period from January to December 2023 increased from 40% to 47.5%. Concurrently, oil accounted for approximately 6% of global trade in 2022, even at elevated prices. Given the relatively low share of oil in the global trade structure, it is unlikely that Saudi Arabia’s refusal of the petrodollar agreement will have a significant impact. This is according to Pigarev.