Saturday, April 16, 2011

Did The World’s Largest Futures Exchange Enable $200 Oil?

Petrochop - A Sign of a Petrocurrency Shift

Did the world’s largest futures exchange enable $200 oil?

What happened?

  • On April 18, 2011, the Chicago Mercantile Exchange launched six Euro-denominated oil contracts - one Brent crude oil and five gasoil.1
  • Pricing, margining and treasury for exchange-cleared oil price management can be fully executed in Euros.

On the surface, this appears to be a reasonable product suite offer from the CME. These contracts are financially-settled and rely on the US dollar oil contracts that trade on ICE, the Intercontinental Exchange. These contracts should make certain trading functions more streamlined for oil exporters to and oil consumers in the Euro-zone. For some users, no need to buy US dollars to effect oil trades. Seems like a nothing-to-see-here moment….

The Petrodollar Economy

Most oil sales throughout the world are denominated in US dollars. Since 1973, OPEC exports have been priced in US dollars. This marketplace gave rise to trillions of petrodollars that get cycled into international oil trade and international US dollar assets. As global oil sales grow (volume times price), the recycling of US dollars into US dollar assets grow.

What if US dollar hegemony in oil settlements changes?

Since most countries rely on oil imports, they are forced to maintain large stockpiles of dollars 2,3,4in order to continue imports. 5 This creates a consistent demand for US dollars and upwards pressure on the US dollar’s value, regardless of economic conditions in the United States. This in turn allegedly allows the US government to issue currency below cost of currency production (seignorage) and bonds at lower interest rates than they otherwise would be able to.6 As a result the U.S. government can run higher budget deficits at a more sustainable level than can most other countries. A stronger US dollar also means that goods imported into the United States are relatively cheap. It appears to be to the US’ advantage to maintain US dollar hegemony.7

If the denomination of oil sales changes to another currency, such as the euro, many countries would sell dollars and cause the banks to shift their reserves, as they would no longer need dollars to buy oil. 8 Forty years of petrodollars would start to get flushed from central bank reserves. This shift in petrocurrency reserve status would lower the volume and velocity of US dollar recycling and thus weaken the dollar relative to the Euro. The EU would accrue the same benefits from Euro-denominated oil sales that the US

What did the CME do?

The CME offered six Euro-denominated oil contracts. The oils are European delivery and the contracts are financially-settled. These are generally for hedging and risk management purposes. At this writing it is unclear if these contracts will be successful (as gauged by turnover). It is unknown if the CME or other energy bourses will offer more oil futures contracts denominated in Euros.

If the contracts are successful, could there then be a move towards Euro-denominated oil sales? There is doubt as to whether oil settlements can really move away from the US dollar. 9 There is evidence that OPEC cannot unilaterally decide to price their exports in Euros. There is no evidence that the network of global oil trade has requested non-US dollar contracts. In the early 2000’s, Russia floated the idea of oil settlements in Euros; the idea died in 2003. Other oil export countries have made more recent pronouncements of movements away from US dollar oil sales that appear to be more political than administrative for now. 10,11

Is this a nothing-to-see-here moment? What is known, however, is that the world’s largest futures exchange has made it possible for any entity to enter into Euro-denominated oil trades. If these contracts get traction and grow, there may be a significant effect upon the USD/Euro relationship. USD 200/bbl oil is in the cards and a petrocurrency change may be a reason cited should the oil market achieve that round number.

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