Should Russia Price Its Oil in Euros?
24 Oct 2003
The U. S. government would like to see the dollar weaker against the currencies of its major trading partners in order to try and stimulate manufacturing sector growth and to reverse the bulging trade deficit. This is part of a package of strategies that the Bush administration is using to try and sustain broad economic recovery ahead of next year's U.S. presidential election - strategies that have so far seen a budget surplus of $237 billion in 2000 turn into a current year deficit of almost $400 billion, heading toward a $600 billion deficit in 2004.
This rapid deterioration in public sector finances, in combination with the deliberate weak dollar policy, means that it will be much more difficult for the administration to control the rate of decline in the dollar, and while it seems clear that the targeted level against the euro, for example, is between 1.15 and 1.20, it is much more likely that we will see a rate around 1.30 in the second quarter of next year. Because of Russia's dependency on dollar-priced exports, it is likely that the ruble will also bear the full extent of dollar weakness relative to the euro over that period.
The U. S. administration is playing a very dangerous game, for while a weak dollar - as with any sharp devaluation - should help reduce the trade deficit, if the budget and current account deficits grow much larger then there is a real danger of large-scale capital retreat from the dollar and a sharp reduction in inward investment. It is clear that the administration is trying to avoid the worst consequences of dollar weakening by encouraging appreciation in a broad range of currencies (i.e. rather than a shift of capital into any one). Currency markets of course are not like that and prefer to keep trading strategies relatively simple, hence the euro continues to be the main beneficiary of the weakening dollar.
The euro is still a relatively immature currency with important structural flaws; for examples some of the largest EU economies such as Britain and Sweden are not part of it, and next year the admission of 10 new member states into the EU risks disrupting the fragile recovery seen this year in core Europe. Nevertheless, the euro is the only real alternative to the dollar and, recognizing the window of opportunity that the U.S. weak dollar policy has presented to it, the EU is now making a political push to fix a more sustainable position of strength for the euro in global trade and savings.
Part of this is trying to persuade Russia to fix some oil export contracts in euros. On the face of it, such a move would make economic sense because while over 70 percent of exports are priced in dollars, over 50 percent of imports are priced in euros. As the dollar weakens against the euro, Russia Inc. is effectively seeing a profit squeeze. The cost base is increasingly being influenced by the euro, not just because of the rising cost of imported goods; as people become more convinced of the strength of the euro relative to the dollar, savings are being switched and the cost of services - everything from restaurant bills to apartment rentals - are increasingly being benchmarked against the euro. Switching some export revenues away from dollars to euros would therefore make sense.
On a purely practical level, of course, there is very little prospect of any significant oil export volumes being priced in anything other than dollars. The global oil industry - pricing, trading and settlement - is based on the dollar, and trading in any other currency would involve extra costs (e.g. currency hedging), extra risk to oil company revenues (because of the extra layer of transaction to benchmark the contract price to the global price of oil, which is in dollars) and make the process unnecessarily complex from the oil industry's viewpoint.
Any globally traded commodity, whether it is oil or tea, is traded in one currency for transparency, cost and risk reasons, and that is not about to change out of political considerations. Global commodities have a self-correcting mechanism to adjust for the strength or weakness of the benchmark currency; one of the reasons for the high oil price today is the weaker purchasing power of the dollar.
However, it does make sense for the EU to try to break the dominance of the dollar in global trade and savings, and politically the timing vis-a-vis the oil market has rarely been better. Several times in its history, OPEC has discussed the idea of pricing some exports in currencies other than the dollar, but mainly because of opposition from Saudi Arabia this idea has never got beyond the initial discussions. Saudi Arabia can less afford now to be seen as strongly supportive of the United States, and the growth of Islamic "nationalism," led by Malaysian Prime Minister Mahathir Mohamad, has again brought this issue to the table.
So far there is little enthusiasm from Arab oil producers, but should Russia adopt a euro export policy, then OPEC, which can more easily impose political decisions on its oil industry, could follow suit.
The battle for a very large slice of global trade and savings is a very high-risk game and is adding a new and much more important element to the already strained relations between the United States and the EU. The global oil industry - cross border exports only - is worth about $450 billion annually, all priced in dollars. The U. S. Treasury benefits enormously from having so much dollar cash in global circulation - much of which ends up in the financial reserves of the oil producers. On a broader scale, the world's largest exporters of general goods, Japan and China, are also large holders of dollars - more than $600 billion in national savings between them - and like the Arab oil producers, they typically use this cash to buy U.S. treasury bonds, thus funding the U.S. deficit.
All of this combines to give a huge subsidy to the U.S. economy and the EU now wants a significant piece of that action.
Once again Russia finds itself very advantageously placed in the middle of global trade restructuring. By carefully steering a middle course and not actually making any decisive moves - a strategy that it has perfected in its relations with the United States and OPEC on energy export issues - it can expect to derive considerable benefit from both sides, especially as negotiations on the terms of WTO entry intensify in 2004.
Christopher Weafer, chief strategist at Alfa Bank, contributed this comment to The Moscow Times.
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