The dominant theme that emerged from the cacophonous OPEC summit that concluded in Riyadh on Nov. 18 was countries that have amassed huge piles of dollars from selling oil don't like seeing the value of their currency reserves eroded. While the host Saudis urged restraint lest the dollar fall even more, Iranian President Mahmoud Ahmedinejad scorned the greenback as a "worthless piece of paper."
Iran is pushing OPEC to shift away from pricing oil in dollars and instead to a basket of currencies that could include the euro. The Islamic Republic is already requiring its customers to pay in euros or yen, partly to avoid a tightening financial squeeze orchestrated by the U.S. But this is largely a symbolic gesture because the price of its oil is still based on dollar benchmarks.
Iran and Venezuela managed to persuade Saudi Arabia to agree to discuss the swooning buck at the next OPEC meeting in Abu Dhabi in December, but engineering a shift to an oil pricing regime based on the euro or another currency anytime soon is far-fetched. "The obstacles are overwhelming," says Edward Morse, energy economist at Lehman Bros. (LEH) in New York. He notes that virtually all oil sold today is based on three benchmarks: West Texas Intermediate traded on the NYMEX; Brent traded on the ICE in London; and Middle East Dubai/Oman crudes as assessed by Platts or settled on the Dubai Mercantile Exchange. All are priced in dollars.
Eroding Power of Currencies
"It is hard to imagine how an exporter and importer of crude oil could agree on mutual terms without pricing off one of these," Morse says. Besides, he adds, producers should know "it is an illusion to think that you are going to have higher real prices globally by switching currencies." Prices, he says, already "basically reflect fair market value."
At the same time, the falling dollar could bring about potentially destabilizing changes to the currencies of the Gulf Cooperation Council countries, which include Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, and Oman. Most are now tied to the dollar. But the populations of the big Gulf producers are grumbling about the eroding purchasing power of their currencies, which have taken a roughly 9% hit against the euro since mid-August, despite rising oil prices and revenues.
Now, even hitherto reluctant governments such as Saudi Arabia's are feeling pressure to take steps to make sure their citizens feel richer, not poorer. "Having the riyal brought down with the dollar reduces the buying power of the average guy," says Brad Bourland, chief of research at Jadwa Investment, a Riyadh-based financial house. "Vacations in Europe and the U.K. seem very expensive."
Losing Confidence in the Dollar
If the dollar continues to fall against the euro—the most closely watched alternative to the dollar—some of the Gulf countries may follow the example of Kuwait, which shifted to a basket of currencies in May, and adjust their dollar-linked exchange rates accordingly. Kuwait has not disclosed the makeup of its basket, but it is thought to be about 65% to 70% dollar-based, along with 15% to 20% euros and a dash of yen, sterling, and other currencies. The dinar has risen about 5% against the dollar since the change, to .2762 dinars per dollar.
A revaluation of one or more of the Gulf currencies, which most analysts think will be initially in the range of a 3% to 5% appreciation, would still be a concern to U.S. policymakers because it risks looking like a vote of no confidence from some of the biggest holders of greenbacks. Heavy selling of dollars and buying of Gulf currencies such as the Saudi riyal may have contributed to the 1% fall of the dollar to a record low of 1.478 dollars to the euro on Nov. 20.
David Woo, currency analyst at Barclays Capital (BCS) in London, thinks the impact on the dollar will be "a relatively short-term phenomenon," because Gulf Central banks and sovereign wealth funds won't necessarily follow up the currency changes with big dollar sales. They may already have restructured their portfolios, he says.
Currencies at a Crossroads
But Monica Malik, a Dubai analyst with investment bank EFG-Hermes, says the initial break from the dollar could lead to expectations of more adjustments if the dollar continues to be weak, as many analysts expect. "If the dollar continues to weaken, speculation will increase," she says.
The most likely country to move, analysts figure, is the United Arab Emirates, whose central bank governor Sultan Nasser al-Suwaidi said on Nov. 13 that the dollar's slide had pushed the country to a "crossroads." Mushtaq Khan, an economist at Citigroup (C) in London, thinks the U.A.E. and possibly other Gulf countries such as Qatar may announce a decoupling from the dollar at the next meeting of the Gulf Cooperation Council in the first week of December. "I think they are increasingly under pressure to do something," he says. "It will send a signal of intent." Much depends on the performance of the dollar over the next couple of weeks.
Of course, there would be some benefits to shifting away from the dollar or increasing the value of local currencies in places such as Saudi Arabia and the U.A.E. For one thing, there's a certain economic logic, since these oil producers are running up huge current account surpluses. Kuwait's and Saudi Arabia's surpluses, for instance, were 43.1% and 27.4% of gross domestic product in 2006, respectively—a trend usually accompanied by rising exchange rates. The total surplus of the Gulf Cooperation Council countries in 2006 was almost $200 billion.
Taking the Sting Out of Inflation
Moving away from the dollar also would give more firepower to the average citizen. It might help ease labor unrest, which has become a growing problem on the vast building sites of the U.A.E. The mostly Asian work force is incensed over the erosion of the value of the dollar-pegged dirham, now trading at 3.67 to the buck.
And raising the value of the local currencies would take some of the sting out of imported inflation, which has become a political issue in countries such as Qatar and the U.A.E., where inflation is 11.8% and 9.3%, respectively. But rents, a big component of these politically sensitive price rises, are likely to continue to soar as long as housing supplies are tight and tens of thousands of expatriates flood into the countries each year.
Driven to Action
The Gulf countries must be careful they don't wind up slashing the value of the dollar component of their own financial reserves, which Mushtaq estimates at a total of around $1.5 trillion. That's one reason top officials of Saudi Arabia, the most important oil exporter, continue to insist they will stick to pegging their riyal to about 3.70 to the dollar. But analysts figure if there looks to be no end to the dollar's plummet in sight, even the conservative Saudis will find it hard not to act.
"Everybody is talking about it," says Roger Diwan, an analyst at consultancy PFC Energy in Washington. "These guys think strategically, not in terms of quarterly returns. But if they don't see a floor, they will have to do something."