What Petrodollars Really Are

What Petrodollars Really Are

Let me explain petrodollars to you directly: they're just the U.S. dollars that oil-exporting countries earn from selling crude oil. I want you to understand that this concept emerged in the 1970s and reshaped trade balances for oil-rich nations, emphasizing the dollar's dominance in global trade.

Back then, and still today, oil sales and surpluses get measured in dollars because it's the most widely used currency. I need to be clear: the U.S. dollar's popularity doesn't depend on oil exporters' goodwill—it's rooted in the U.S. being the largest economy with robust, secure capital markets.

Understanding Petrodollars

As I mentioned, petrodollars are oil export revenues denominated in U.S. dollars—they're not a distinct currency; they're simply the U.S. dollars accepted as payment by an oil exporter.

You should know that global oil production averaged about 96 million barrels per day in 2023. At that pace, with an average price of $85 per barrel, it would generate an annual global petrodollar supply of about $2.98 trillion.

Petrodollars serve as the primary source of revenue and wealth for many OPEC members, plus non-OPEC exporters like Russia, Qatar, and Norway. Remember, just as the petrodollar isn't a currency, it's not a global trading system either—it's the traditional preference of non-U.S. oil suppliers for using the dollar.

How Petrodollar Recycling Works

Oil exporters prefer the USD because it's the preeminent global investment currency, making it the most convenient store of value for accumulated oil revenue that needs to earn a return to be useful.

An early example I can point to is the 1974 deal between the U.S. and Saudi Arabia, which funneled Saudi petrodollars into U.S. Treasurys. Subsequent deals used Saudi oil proceeds to pay for U.S. aid, development projects in Saudi Arabia, and U.S. weapons sales to the kingdom.

Today, many oil exporters invest their petrodollars in stocks, bonds, and other financial instruments through sovereign wealth funds. Take Norway's fund, the world's largest—it was valued at about $1.5 trillion at the end of 2023. Inflows from the Norwegian state that year were just over $67 billion, with an annual return of 16.1%. In 2023, 71% of the fund consisted of stocks, including major holdings in Microsoft Corporation (MSFT), Apple Inc. (AAPL), and Alphabet (GOOG).

Assessing the Stability of the Petrodollar System

You'll often see speculation online about the petrodollar system collapsing—usually from people in crypto forums who don't fully grasp it, just that it's supposedly doomed. More serious looks consider U.S. rivalries with rising powers, its use of sanctions, and strengthening ties between OPEC nations and BRICS members. Countries like China and Russia are increasingly settling in non-dollar currencies.

The petrodollar might lose some influence, but not soon. Right now, a collapse seems unlikely. U.S. dollar holdings have dropped, but it's still the top global reserve currency with no real competition. According to the International Monetary Fund, in Q1 2024, the dollar accounted for about 58% of allocated reserves—far more than euros (20%), yen (5.5%), pound (4.9%), or renminbi (2.6%).

Understanding the Petrodollar vs. Petroyuan Debate

To assess why oil exporters prefer U.S. dollars, consider the claims over the past decade that the petrodollar faces a challenge from the petroyuan—oil exports paid in Chinese currency.

All oil buyers hold or can access U.S. dollars easily, while the yuan is mostly held by China and Chinese companies. Unlike the dollar, the renminbi isn't freely convertible; its exchange rate is managed by China's central bank.

U.S. dollars from oil exports can be invested worldwide, including in the huge eurodollar market. Yuan proceeds can't be invested as widely outside China and only inside at the government's discretion. Chinese markets have grown, but they're smaller and less liquid than U.S. ones. In short, it's not oil settlements that make the dollar primary—its global reserve status is what matters, established long before major oil exporters rose.

Examining the Controversies Surrounding Petrodollars

When petrodollars get recycled into overseas investments or home development, they can yield positive returns. But results turn negative when they're used to fortify oppression, fuel arms races, or wage wars.

Recent events like the murder of Jamal Khashoggi by Saudi agents and Russia's invasion of Ukraine raise concerns that petrodollars finance war and violations while shielding perpetrators. Russia has worked to counter 2022 sanctions by de-dollarizing, but it's not a path others are eager to follow.

Common Questions About Petrodollars

Is the petrodollar a currency? No, they're just U.S. dollars from oil exports—there's no official system, and reinvestment is sometimes called recycling.

Does the dollar's role depend on oil settlements? No, oil sales use the dollar because of its acceptance, which aids investment.

Is the petroyuan coming? Not as a dominant rival—exporters can choose currencies, but yuan is best for China dealings, with smaller, less liquid markets.

Are petrodollars fueling war? Saudi violations and Russia's actions suggest oil wealth emboldens rulers—like any resource, it can be used for good or ill, showing the dollar's enduring power.

Did Saudi Arabia drop the petrodollar? Rumors in June 2024 claimed it refused to renew a 50-year deal, but that was fake news—there was no formal agreement with an expiration, and searches spiked before it was debunked.

Final Thoughts on the Future of Petrodollars

Petrodollars—U.S. dollars from oil exports—play a vital role in global trade and finance, strengthening ties between exporters and importers. The preference for dollar settlements underscores its status as the world's foremost currency due to acceptance and investment ease. Despite speculation about alternatives like the petroyuan, the dollar's dominance in oil trade and as a reserve currency isn't likely to fade soon.