Saudi emerges king at OPEC meet: Oil prices will remain low for now

oilVivek Kaul

The oil ministers of the Organization of Petroleum Exporting (OPEC) countries met in Vienna yesterday. They decided to keep the total production of oil coming from OPEC at 30 million barrels per day. This is one million barrels per day more than OPEC’s estimate of the demand for its oil in 2015.
“It was a great decision,” said Saudi Oil Minister Ali al-Naimi, after talks which lasted for around five hours. With this decision not to cut production the price of oil fell further, and as I write this the price of Brent crude oil stands at $72.2 per barrel of oil.
The decision not to cut production went against the demand of OPEC members like Iran and Venezuela, who had demanded that production be cut. A falling oil price is hurting these countries badly given that money earned from selling oil is a major source of revenue for the respective governments.
Also, in the past, OPEC has been quick to cut production whenever prices have fallen and that has ensured that prices don’t fall any further. But that doesn’t seem to be happening this time around. Saudi Arabia, the largest producer of oil within OPEC, wants to drive down the price of oil.
The question that crops up here is why did OPEC go with what Saudi Arabia wanted it to? It has 11 other countries as members as well.
While OPEC has been regularly referred to as a cartel, it is important to understand that the structure of OPEC is different from that of a cartel. It is probably better to define the structure of OPEC as what economists call a “leading firm” model of oligopoly, a market which is dominated by a small number of sellers and in which the largest producer sets the price and the others follow.
Saudi Arabia is the largest producer within OPEC. Within OPEC, it also has the almost unquestioned support of what are known as the sheikhdom states of Bahrain, Kuwait, the United Arab Emirates, and Qatar.
These countries have faced threats from other OPEC members, like Iraq and Iran, in the past. For many years, Iraq had been eyeing Kuwait. It had tried to annex Kuwait in 1961 (and it tried again in the early 1990s). The support of Saudi Arabia, the largest nation in the region, is very important for these countries. Hence, these countries tend to go with Saudi Arabia, not leaving much space for the other member countries to disagree.
Moral of the story: OPEC does what Saudi Arabia wants it to do. And these days Saudi Arabia seems to want lower oil prices. Why is that the case? Look at the table that follows. The table shows the daily oil production in the United States, which had fallen to around 4 million barrels per day in 2008. It has since jumped up again to around 9 million barrels per day, the kind of level not since the mid 1980s.
This has happened primarily because of a boom in shale oil production in the United States. As Javed Mian writes in Stray Reflections newsletter for the month of November “The US pumped 8.97 million barrels a day by the end of October (the highest since 1985) thanks partly to increases in shale-oil output which accounts for 5 million barrels per day.”
The more shale oil United States produces the lesser it has to depend on OPEC and other parts of the world, to fulfil its massive oil requirements. The trouble is that shale oil is expensive to produce and is viable only if oil continues to sell at a certain price. Given this, Saudi Arabia wants to ensure that price of oil is driven down further, so that it can drive the shale oil producers out of business.
There are various estimates about the oil price at which it is viable to produce shale oil. A report brought out by Deutsche Bank said that around 40% of shale oil production in the United States next year, would be unviable if the price of oil fell below $80 per barrel. Very recently, this was a sentiment echoed by the chief economist of the International Energy Agency as well.
Nonetheless, Maria van der Hoeven, executive director of the International Energy Agency, contradicted her chief economist by telling Reuters recently that 82 percent of the American shale oil firms had a break-even price of $60 or lower.
There are still other estimates. As Mian writes in his newsletter “The median North American shale development needs an oil price of $57 to breakeven today, compared to $70 last year according to research firm IHS.”
Analysts at Citibank recently said that the price of oil would have to fall below $50 a barrel for completely halting shale oil production in the United States. Also, many shale oil companies would continue to remain viable for an oil price of anywhere between $40 to $60 a barrel. It would be safe to say that there are as many break-even prices for shale oil as there are analysts. And it is very difficult to figure out which of these estimates is correct.
This is not the first time Saudi Arabia is following the strategy of bleeding out its competitors. It did the same nearly three decades back. “This has happened once before. By the mid-1980’s, as oil output from Alaska’s North Slope and the North Sea came on line (combined production of around 5-6 million barrels a day), OPEC set off a price war to compete for market share. As a result, the price of oil sank from around $40 to just under $10 a barrel by 1986,” writes Mian.
Hence, Saudis are putting to work a strategy that they have used in the past. Nevertheless, it doesn’t seem to have had the necessary impact on the production of oil by shale oil firms in the United States. On November 10, earlier this month, the US Energy Information Administration said that the seven largest shale oil players would be producing 125,000 barrels per day more in December than they had in November.
One reason for this is that the money that has already gone into producing shale oil is essentially a sunk cost. Hence, production is not going to be stopped immediately. As Ben Hunt who writes the Epsilon Theory newsletter puts it “T
here’s just too much non-cartelized money, technology, and political capital invested in US shale production to slow it down.”
Also, companies already have long term production contracts in place. These contracts require that they deliver a minimum level of production, even if it means selling at a loss. “Failure to comply could mean the loss of the lease and any future upside when prices [are] normalized,” writes Chip Register on Forbes.com.
Legendary oil man, T Boone Pickens feels that Saudi Arabia has entered into a stand-off to “see how the shale boys are going to stand up to a cheaper price.”
To conclude, Saudi Arabia driving down the price of oil hasn’t yet had an impact on shale oil production. Given this, it is likely that Saudi Arabia led OPEC will continue to drive down the oil price in the months to come. “In the current cycle, though, prices will have to decline much further from current levels to curb new investment and discourage US production of shale oil,” writes Mian.
It is also possible that the United States government may decide to intervene and introduce “tariffs on cheap foreign oil imports,” to keep the local shale oil industry viable.
The United States government will also have to take into account the fact that Saudi Arabia buys and sells oil in dollars. This ensures that in order to earn these dollars countries carry out international trade in dollars and accumulate a major part of their foreign exchange in dollars. This ensures that dollar continues to have an “exorbitant privilege” allowing United States to repay its debt to foreigners by simply printing them.
Further, it also helps keep the interest rates in the United States low, as countries line up to invest their foreign exchange reserves in treasury bonds issued by the United States government. Given this, its a Catch 22 situation for the United States. Does it encourage its local shale oil industry and reduce its dependence on importing oil from the Middle East? Or does it work against the “exorbitant privilege” of the dollar? Its not an easy choice to make.
Hence, its safe to predict that oil prices will continue to be low in the short-term. There are too many interplaying factors at work making it impossible to predict how things will turn out to be in the long run.
All I can say is, stay tuned.

The column originally appeared on www.FirstBiz.com on Nov 28, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

Oil prices at a 4-year low: Decoding why Saudi Arabia won’t mind low prices for some time

oil

Vivek Kaul 

Oil prices have fallen to a four year low. As I write this the price of Brent crude oil stands at $82.82 per barrel, down 30% from June 2014.
The latest drop in price has come after Saudi Arabia, the biggest producer of oil within the Organisation of Petroleum Exporting Countries(OPEC), the global oil cartel, decided to
cut the price at which it sold oil to the United States by roughly 45 cents to a barrel. At the same time it increased the price to customers in Europe and Asia, for the first time in five months.
The theory going around for sometime has been that Saudi Arabia needs the price of oil to be at least at $83-84 per barrel to balance its budget. Hence, it won’t allow the price of oil to fall below that level. But that as we have seen hasn’t turned out to be the case with the price of Brent crude now less than $83 per barrel.
So, the question is why is Saudi Arabia allowing the price of oil to fall and taking a hit on its income? On many past occasions, the country has cut production when the price of oil is falling. This has helped the country prevent a fall in the price of oil.
As analysts at Merrill Lynch write in a recent report titled
Does Saudi Want $85 oil Our analysis suggests that since 2008, on average, a 10% drop in oil prices has historically led to a 1.5% reduction in Saudi production 3 months later, rising to 2% after 6 months.” Nevertheless, it doesn’t seem to be doing that this time around.
So what has changed? In 2013, United States
became the largest producer of oil in the world, displacing Saudi Arabia. The shale oil fields of the United States are producing a lot of oil, and this has helped the country to become the largest producer of oil in the world. This has led to American imports of oil from Saudi Arabia coming down. Data from the US Energy Information Administration tells us that the imports from Saudi Arabia comprised of around 4.6% of total US oil consumption in August 2014. This is down from 7% in August 2013.
In fact, over the last two months, American imports of oil from Saudi Arabia
have fallen under one million barrels per day, against 1.4 million barrels earlier. If one looks at the data over a longer period the situation looks even more grim. Over a period of last six years, the production of oil in the United States has increased by 70%. This has led to the reduction of oil imports from OPEC by half. Saudi Arabia is the biggest producer of oil within OPEC.
Saudi Arabia is trying to set this situation right. Shale oil is expensive to produce. Given this, it is viable for companies to produce oil, only if the price of oil remains at a certain level. As the Merrill Lynch analysts point out “
With production costs ranging from $50 to $75/bbl at the well head, a decline in Brent crude oil prices to $85 would likely be a major blow to US shale oil players and lead to a significant slowdown in investment.”
Hence, Saudi Arabia is trying to make the production of shale oil unviable for companies which produce shale oil, by driving down the price of oil. The question is how long can the Saudis keep driving the price of oil?
Loren Steffy writing for Forbes.com points out that “The Saudis appear willing to use the abundance of U.S. production to allow prices to keep sliding, enabling the kingdom, which can profit from oil at as little as $30 a barrel, to grab a larger share of the global market.”
While the cost of production of oil in Saudi Arabia maybe low, there are other costs that need to be taken into account.
David Strahan in his book The Last Oil Shock explains that that over the years in Saudi Arabia is that as oil prices have gone up, the rulers have been able to run one of the most lavish welfare systems in the world. This has helped them buy political legitimacy and the support of its citizens. For a very long time, the citizens of Saudi Arabia paid no tax, yet had access to free healthcare and education. At the same time, housing, electricity, food and fuel were subsidized. All this was possible because of all the money that was being earned by selling oil. And that is why for Saudi Arabia to balance its budget (i.e. the expenditure of the government is equal to its income), it needs to sell oil at a price of $83-84 per barrel.
Given this, will the Saudis start cutting production and pushing the price of oil up? “
Much has been written recently about the marginal costs of production of crude oil, and how much which nation will “hurt” if West Texas Intermediate oil prices fell below the US$ 80 mark,” says Vijay L Bhambwani, CEO of BSPLIndia.com. West Texas Intermediate is the American oil benchmark and is currently at $77.2 per barrel.
Nevertheless, as long as long as Ghawar, Safania, Shayba, Abqaiq, Berri, Manifa, Abu Safah, Faroozan oil fields are viable, Saudis can sustain even lower prices, feels Bhambwani. At the same time, the fact that Aramco (officially known as Saudi Arabian Oil Company) has deep pockets is a point worth remembering. “Saudis can produce low cost arab light sweet crude very cost efficiently and only the recent state welfare schemes implemented after the arab spring, have raised the marginal costs. Even a slight rollback / delayed released of the additional welfare payments (US $ 36 billion) can add sizeable cash flow into the Saudi national balance sheet and give it additional staying power,” adds Bhambwani.
Also, it is worth remembering that the Saudi central bank has reserves worth $734.7 billion. Further, as Edward Chow a senior fellow at the Center for Strategic & International Studies in Washington,
recently told Bloomberg “The Saudis ran deficits from the mid-1980s until the late 1990s and may be prepared to do so again.”
What this tells us is that the Saudis can easily sustain low oil prices in the short-term, if they are looking to break the backs of the shale oil companies. At the same time low oil prices will hurt Iran, much to the delight of the Saudins.
To conclude, any fall in price of oil, will benefit India, and help the government further control its fiscal deficit. Fiscal deficit is the difference between what a government earns and what it spends. So, India should hope that Saudi Arabia continues with its current strategy of driving down the price of oil.

The column appeared on www.FirstBiz.com on Nov 6, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

Why oil prices are falling despite the rise of ISIS

oil

Vivek Kaul

All other things staying the same, oil prices have always been inversely proportional to peace in the Middle East. The moment any tension or war breaks out in the Middle East, oil prices start rising. The logic is pretty straight forward given that the region has some of the biggest oil fields in the world and produces bulk of the oil that the world consumes.
Any tension is seen as a threat to supply of oil in the future, and taking that possibility into account, oil prices start to go up.
But this theory doesn’t seem to be working in the recent past. The Islamic State of Iraq and Syria (ISIS) has been waging a war in the region for a while now, but oil prices instead of going up, have been coming down. The international crude oil price of Indian Basket as on September 30, 2014, stood at $ 95.34 per barrel (bbl). The price must have fallen more since then, but no new data has been released given that the government has been on a five day holiday.
The brent crude oil is currently trading at around $92.8 per barrel. This is a fall of more than 19% since June 2014. The more ISIS has grown stronger in the Middle East, the more oil prices have fallen.
How does one explain this dichotomy? There are multiple reasons behind this. ISIS has managed to capture the largest oilfield in Syria and now controls 60% of the oil production in the country. Nevertheless this has had no impact on the price of oil globally. The reason for this is straightforward. Syria is the 32nd largest producer of oil in the world and in 2013 produced only 0.48% of the oil produced globally.
ISIS has also managed to take over a number of oil fields in Iraq. But they haven’t been able to move into the Southern part of the country where the majority of the oilfields are located. Iraq is the seventh largest producer of oil in the world and in 2013 produced around 3.75% of global oil. Hence, any disruption of oil supply in Iraq will have some impact on global prices. But that hasn’t happened.
As Crisil Research explains in a research report titled
Falling crude, LNG, coal prices huge positive for India “This is because the likelihood of Islamic State progressing towards southern Iraq, which has about 65-70% of the country’s oil production and reserves, seems minimal. For one, that part of Iraq is dominated by Shia Muslims who do not support Islamic State.”
Further, ISIS also needs money to keep running their operations. And that means that they need to keep pumping oil out of the oilfields that they have captured. The oil is sold at a discount to the world price of oil, to Turkey, which in turn, resells it in Europe. This is another reason why oil prices haven’t risen. The supply from the captured oilfields is still hitting the world market.
Over and above this, the oil supply from Libya is coming back. A newsreport points out that Libya is pumping close to 925,000 barrels of oil per day. This has been the highest since Muammar Gaddafi was overthrown from power in Libya. Libya in 2013 produced around 0.85% of global oil production. These are the short term reasons as to why the price of oil hasn’t gone up, despite the advance of the ISIS.
There are several long term reasons as well. The United States and Canada are producing much more oil than they were a few years back. Data from the U.S. Energy Information Administration shows that United States in 2013 produced 12.35 million barrels per day. This is a massive increase of 35% since 2009. A recent report in the www.businessinsider.com points out that “In 2010 the [United States] still imported half of the crude it consumed, but the U.S. Energy Information Administration forecasts that will fall to little more than 20 percent next year.”
In case of Canada the production has gone up by 22.8% to 4.07 million barrels per day between 2009 to 2013. This massive increase in oil production has come from a boom in shale oil output. As a recent report in the Financial Times pointed out “Booming shale oil output has pushed US production to a 28-year high at the expense of imports.”
This has led to a situation where the United States has stopped importing oil from countries it was doing earlier. Take the case of Nigeria. The country did not import a single barrel of oil to the United States in July 2014. The country till four years back was one of the top 5 exporters of oil to the United States.
In fact as a October 2 blog on the Financial Times website points out “At its peak in February 2006, the US imported 1.3m b/d from Nigeria – equal to roughly one super-tanker the size of the Exxon Valdez every day. By 2012, Nigeria was already selling just 0.5m b/d, but was still one of the top-5 suppliers to the US, alongside Saudi Arabia, Canada, Mexico and Venezuela.”
Columbian oil exports to the United States have also fallen by a one third up to July this year, in comparison to the same period last year.
All this oil which was going to the United States earlier is now hitting the world market and is a major reason why oil prices have not rallied in the recent past. Interestingly, the US production of oil is now more than one third of the oil being produced in the Middle East. All this has had a huge impact on oil prices given that the United States is the biggest consumer of oil in the world.
Higher supplies from Iran are also expected to hit the market. Currently the country is facing international sanctions and is not allowed to sell a major portion of the oil that it produces. In 2013, Iran produced 4.77% of the total global oil production and was the fourth largest producer of oil in the world. As Crisil Research points out “In case of Iran, production is expected to return to the pre-sanctions levels of 4.4 mbpd from current levels of 3.1 mbpd as Iran is expected to co-operate with the international community after the change of regime post-elections.”
This is expected to happen because over the last two years international sanctions have had a severe impact on Iran. “In 2012 and 2013, Iran’s GDP registered a negative growth, inflation rose more than 60% cumulatively, and Iranian Rial depreciated by more than 85% cumulatively. Since Iran’s economy is oil-dependent, with oil exports contributing to ~85% of total exports, it will have to increase its oil exports to repair its economy,” Crisil research points out.
All these reasons, along with the fact that China’s economic growth is slowing down have ensured that oil prices haven’t gone up in the recent past. China is the second largest consumer of oil in the world after the United States.
In the recent past several analysts have suggested that Saudi Arabia and United States are working together to drive down the price of oil. This is being done to cut off the funding of ISIS. As oil prices fall, the price at which ISIS will have to sell oil will fall further. And that way, they amount of money they earn will come down. The question that needs to be answered is that how much truth does this theory have. I will try and answer that in the next piece. Watch this space.
The article originally appeared on www.FirstBiz.com on Oct 7, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

Why Moily’s idea of buying oil from Iran won’t work

M-Veerappa-Moily_0Vivek Kaul
India is thinking of importing more oil from Iran than it currently does. In a letter to the Prime Minister Manmohan Singh, oil minister Veerapa Moily, suggested that “An additional import of 11 million tonnes during 2013/14 would result in reduction in forex outflow by $8.47 billion (considering the international price of crude oil at $105 per barrel).” (As reported by Reuters).
This is because Iran accepts payments in rupees and not dollars as is the case with most of the other oil exporters. This will help India save precious foreign exchange.
While theoretically this idea makes immense sense, it is not really a solution that India will be able to execute. The United States and the European Union have placed sanctions on Iran over its nuclear programme. As Reuters reports “U.S. and EU sanctions placed on Iran over its nuclear programme have reduced its oil exports more than half from pre-sanction levels of about 2.2 million barrels per day (bpd). In the first half of 2013, imports of Iranian oil from its four biggest buyers – China, India, Japan and South Korea – fell more than a fifth from a year ago to around 960,000 bpd.”
India’s oil imports from Iran have declined by 46% to 185,700 barrels per day during the first seven months of the year, in comparison to the same period last year. And this is because of the sanctions.
Oil is bought and sold internationally in dollars. This started sometime after the Second World War. President Franklin D Roosevelt realised that a regular supply of oil was very important for the well being of America or what came to be known as the great “American dream”.
After the end of the Second World War Roosevelt travelled quietly to USS Quincy
a ship anchored in the Red Sea. Here he was met by King Ibn Sa’ud of Saudi Arabia, a country, which was by then home to the biggest oil reserves in the world.
The obsession of the Untied States with the automobile had led to a swift decline in domestic reserves, even though America was the biggest producer of oil in the world at that point of time. The country needed to secure another source of assured supply of oil. So in return for access to oil reserves of Saudi Arabia, King Ibn Sa’ud was promised full American military support to the ruling clan of Sa’ud. This oil was sold in dollars.
This was one of the major reasons behind the dollar becoming the international reserve currency. Every country in the world needed oil. And for countries that did not produce enough of their own oil they needed dollars they could use to buy oil from other countries.
This continued till the 1970s. In the seventies, after the end of the gold standard, the dollar started to lose value rapidly against other currencies and against gold. This meant that the purchasing power of the OPEC countries which sold oil in dollars and then used those dollars to import goods they did not produce, came down dramatically.
As William Greider writes in 
Secrets of the Temple: How the Federal Reserve Runs the Country “The dollar had already lost one-third of its value in only half a dozen years and seemed headed toward even steeper decline… Oil trades worldwide in dollars and if the U.S. was going to permit a free fall in the dollar’s value, that meant the oil-producing nations would received less and less real value for their commodity.”
One impact of this was OPEC countries raising the price of oil. Another impact was that some of the OPEC countries wanted to price oil in several currencies rather than just the American dollar. Jahangir Amuzegar, who was an economist by training, and had been a minister in the government of Iran, as well as a negotiator for OPEC, outlined some of these proposals in a 1978 article. In this article he outlined several currency combinations that could be used to price oil. Iraq, Qatar, United Arab Emirates and Venezuela were in support of this plan.
The idea was not to be dependent on one currency, but a number of currencies and hence iron out any fluctuations in the value of one currency. Moving to a basket of currencies at that point of time clearly made sense for OPEC as far as future revenues were concerned.
As per estimates of the US department of treasury, Saudi Arabia, the largest member of OPEC, would have been better off if it had priced oil in a basket of currencies instead of the dollar, in all but 18 months since 1973.
So what was stopping Saudi Arabia and OPEC from moving to pricing oil in a basket of currencies rather than the dollar? As David E Spiro writes in 
The Hidden Hand of American Hegemony: Petrodollar Recycling and International Markets: “The Saudis, however, had the greatest proportion of dollar-denominated reserves in OPEC. This means that their reserves were diminished by the depreciation of the dollar (compared to the basket of their imports). But it also meant that they had the most to lose if a shift by OPEC to a basket of currencies threatened international confidence in the dollar. Having agreed to invest so much in dollars, the Saudis now shared a stake in maintaining the dollar as an international reserve currency. On the one hand dollars constituted 90% of Saudi government revenues in 1979, and those revenues were subject to the same fluctuations as the dollar. On the other hand, the Saudi investments were, roughly at same time 83% dollar denominated. The choice was whether to stabilise current revenues threatening the worth of all the past revenues (since invested in dollar assets).”
Also, as mentioned earlier, Roosevelt had stuck a deal with the ruling clan of Al Sa’uds. It is important to remember that the American security guarantee made by President Roosevelt after the Second World War was extended not to the people of Saudia Arabia nor to the government of Saudi Arabia but to the ruling clan of Al Sa’uds. So they had an intrest in selling oil in dollars and keeping the dollar going as an international reserve currency.
Also other than being the largest producer of oil Saudi Arabia also had the largest reserves among all OPEC countries. It had 39% of the proven OPEC reserves. Within OPEC it had the almost unquestioned support of what were known as the sheikhdom states of Bahrain, Kuwait, United Arab Emirates and Qatar. These countries faced threats from other OPEC members like Iraq and Iran. For many years, Iraq had been eyeing Kuwait. It had tried to annex Kuwait in 1961 (and then again in the early 1990s).
Hence, the support of Saudi Arabia, the largest nation in the region, was important for them
If we added the reserves and production of the sheikdom countries which supported Saudi Arabia, they were together responsible for 50% of OPEC’s production and owned nearly 61% of its proven reserves. So, when Saudi Arabia made the decision that OPEC oil would be continued to be priced in dollars, there wasn’t much option for the other OPEC members but to follow what the largest member had decided.
What this brief history of oil tells us is that for dollar to continue being an international reserve currency, it is very important that oil continues to be sold in dollars. Other countries need to earn these dollars whereas the United States has the exorbitant privelege of simply printing them and spending them.
Iran has been trying to challenge this hegemoney of the dollar for a while now. It 
has been trying to move the buying and selling of oil away from the US dollar. In late 2007, Iran claimed to have moved all of its oil sales to non dollar currencies, with most of it being sold in euros and a small part in yen. There were no independent reports confirming the same.
The United States and Iran have been at each other’s throats since the 1979 revolution in Iran which overthrew the King. Lately there has been tension because of Iran’s nuclear programme.
Mahmoud Ahmadinejad, who was the President of Iran till around a month back, has called the dollar “
a worthless piece of paper”. News reports suggest that Iran has started accepting renminbi from China and rubles from Russia in lieu of the oil that it exports to these countries.
In fact in a November 2007, summit of OPEC, Iran had suggested that OPEC oil should be sold in a basket of currencies rather than the American dollar. But it did not get the support of other members except Venezuela. Hugo Chavez, the late President of Venezuela, was known to be a vocal critic of the United States

On February 17,2008, Iran set up the Iranian Oil Bourse, for the trading of petroleum, petrochemicals and natural gas, in currencies other than dollar, primarily the euro and the Iranian rial. But the exchange since inception has not traded in oil but products made out of oil which are used as a feedstock in pharmaceutical and plastic industries.
Reports in the Iranian press suggested that the bourse started trading oil in non dollar currencies from March 20,2012. India wanted to pay for Iranian oil, either in gold or in rupees. If India paid in rupees, Iran could use those rupees to import goods from India.
This move to pay for oil in rupees or gold was a clear attempt to undermine the dollar in the buying and selling of oil, something that keeps the dollar at the heart of the international financial system. Hence, great pressure was applied by America on India to stop its oil imports from Iran and source its needs from some other producer.
India’s oil imports from Iran in April 2012 fell by 34.2% to 269,000 barrels per day from 409,000 barrels per day in March 2012. The government of India asked the Indian oil refiners to cut Iranian oil imports and they obliged.
What this tells us in a very clear way is that even though the US dollar may not be in the best of shape, but any attempts to mess around with its international ‘currency’ status will not be taken lying down. And for dollar to maintain its international currency status it is important that oil continues to be bought and sold in dollars.
So if the United States could pressurise India into cutting down its oil purchases from Iran in March 2012, it can do the same in September 2013. Any move away from dollar , which in turn will undermine access to “easy money” which has been so important to what is now called the American way of life.
Also it is best to remember that financially America might be in a mess, but by and large it still remains the only superpower in the world. In 2010, the United States spent $698billion on defence. This was 43% of the global total.
The article originally appeared on www.firstpost.com on September 2, 2013 

(Vivek Kaul is a writer. He tweets @kaul_vivek) 
 

Why the dollar continues to look as good as gold

3D chrome Dollar symbol
Vivek Kaul 
 
Over the last few years a mini industry predicting the demise of the dollar has evolved. This writer has often been a part of it. But nothing of that sort has happened.
There are fundamental reasons that have led this writer and other writers to believe that dollar is likely to get into trouble sooner rather than later. The main reason is the rapid rate at which the Federal Reserve of United States has printed dollars over the last few years. This rapid money printing is expected to create high inflation sometime in the future.
But whenever markets have sensed any kind of trouble in the last few years money has rapidly moved into the dollar. In fact, even when the rating agency Standard & Poor’s downgraded America’s AAA status, money moved into the dollar. It couldn’t have been more ironical.
What is interesting nonetheless that the doubts on the continued existence of the dollar are getting graver by the day. Gillian Tett, the markets and finance commentator of 
The Financial Times has a very interesting example on this in her latest column Is Dollar As Good as Gold published on March 1, 2013.
As Tett writes “Should we all worry about the outlook for the mighty American dollar? That is a question that many economists and market traders have pondered as economic pressures have grown. But in recent weeks Virginia’s politicians have been discussing it with renewed zeal. Last month Bob Marshall, a local Republican, submitted a bill to the local assembly calling on the state to study whether it should create its own “metallic-based” currency.”
The reason for this as the bill pointed out was that “Unprecedented monetary policy actions taken by the Federal Reserve … have raised concern over the risk of dollar debasement.”
In fact Virginia is not the only state in the United States that has been talking about a currency backed by a precious metal(read gold). As Tett puts it “So guffaw at the Virginia bill if you like. And if you want an additional chuckle, you might also note that a dozen other state assemblies, in places such as North and South Carolina, have discussed similar ideas; indeed, Utah has a gold and silver depository which is trying to back debit cards with gold.”
The point is that the debate on the demise of the dollar if it continues to be printed at such a rapid rate, is now moving into the mainstream.
So what will be the fate of the US dollar? Will it continue to be at the heart of the global financial system? These are questions which are not easy to answer at all. There are too many interplaying factors involved.
While there are fundamental reasons behind the doubts people have over the future of the dollar. There are equally fundamental reasons behind why the dollar is likely to continue to survive. But one good place to start looking for a change is the composition of the total foreign exchange reserves held by countries all over the world. The International Monetary Fund puts out this data. The problem here is that a lot of countries declare only their total foreign exchange reserves without going into the composition of those reserves. Hence the fund divides the foreign exchange data into allocated reserves and total reserves. Allocated reserves are reserves for countries which give the composition of their foreign exchange reserves and tell us exactly the various currencies they hold as a part of their foreign exchange reserves.
Dollars formed 71% of the total allocable foreign exchange reserves in 1999, when the euro had just started functioning as a currency. Since then the proportion of foreign exchange reserves that countries hold in dollars has continued to fall. In fact in the third quarter of 2008 (around the time Lehman Brothers went bust) dollars formed around 64.5% of total allocable foreign exchange reserves. This kept falling and by the first quarter of 2010 it was at 61.8%. It has started rising since then and as per the last available data as of the third quarter of 2012, dollars as a proportion of total allocable foreign exchange reserves are at 62.1%. The fall of the dollar has all along been matched by the rise of the euro. But with Europe being in the doldrums lately it is unlikely that countries will increase their allocation to the euro in the days to come. Between first quarter of 2010 and the third quarter of 2012, the holdings of euro have fallen from 27.3% to 24.14%.
So the proportion of dollar in the total allocable foreign exchange reserves has fallen from 71% to 62.1% between 1999 and 2012. But then dollar as a percentage of total allocable foreign exchange reserves in 2012 was higher than it was in 1995, when the proportion was 59%.
So when it comes to international reserves, the American dollar still remains the currency of choice, despite the continued doubts raised about it. One reason for it is the fact that there has been no real alternative for the dollar. Euro was seen as an alternative but with large parts of Europe being in bigger trouble than America, that is no longer the case. Japan has been in a recession for more than two decades not making exactly yen the best currency to hold reserves in.
The British Pound has been in doldrums since the end of the Second World War. And the Chinese renminbi still remains a closed currency given that its value is not allowed to freely fluctuate against the dollar.
So that leaves really no alternative for countries to hold their reserves in other than the American dollar. But that is not just the only reason for countries to hold onto their reserves in dollars. The other major reason why countries cannot do away with the dollar given that a large proportion of international transactions still happen in dollar terms. And this includes oil.
The fact that oil is still bought and sold in American dollars is a major reason why American dollar remains where it is, despite all attempts being made by the American government and the Federal Reserve of United States, the American central bank, to destroy it. And for this the United States of America needs to be thankful to Franklin D Roosevelt, who was the President from 1933 till his death in 1945 (in those days an individual could be the President of United States for more than two terms).
At the end of the Second World War Roosevelt realised that a regular supply of oil was very important for the well being of America and the evolving American way of life. He travelled quietly to USS 
Quincy, a ship anchored in the Red Sea. Here he was met by King Ibn Sa’ud of Saudi Arabia, a country, which was by then home to the biggest oil reserves in the world.
The United States’ obsession with the automobile had led to a swift decline in domestic reserves, even though America was the biggest producer of oil in the world at that point of time. The country needed to secure another source of assured supply of oil. So in return for access to oil reserves of Saudi Arabia, King Ibn Sa’ud was promised full American military support to the ruling clan of Sa’ud.

Saudi Arabia over the years has emerged as the biggest producer of oil in the world. It also supposedly has the biggest oil reserves. It is also the biggest producer of oil within the Organisation of Petroleum Exporting Countries (OPEC), the oil cartel. Hence this has ensured that OPEC typically does what Saudi Arabia wants it to do. Within OPEC, Saudi Arabia has had the almost unquestioned support of what are known as the sheikhdom states of Bahrain, Kuwait, United Arab Emirates and Qatar.
In fact, in the late 1970s efforts were made by other OPEC countries, primarily Iran, to get OPEC to start pricing oil in a basket of currencies (which included the dollar) but that never happened as Saudi Arabia put its foot down on any such move. This led to oil being continued to be priced in dollars and was a major reason for the dollar continuing to be the major international reserve currency.
It is important to remember that the American security guarantee made by President Roosevelt after the Second World War was extended not to the people of Saudia Arabia nor to the government of Saudi Arabia but to the ruling clan of Al Sa’uds. Hence, it is in the interest of the Al Sa’ uds to ensure that oil is continued to be priced in American dollars.
And until oil is priced in dollars, any theory on the dollar being under threat will have to be taken with a pinch of salt because the world will need American dollars to buy oil. Also it is important to remember that financially America might be in a mess, but by and large it still remains the only superpower in the world. In 2010, the United States spent $698billion on defence. This was 43% of the global total.
So dollar in a way will continue to be as good as gold. Until it snaps.

The piece originally appeared on www.firstpost.com on March 5, 2013 
(Vivek Kaul is a writer. He tweets @kaul_vivek and continues to actively bet against the dollar by buying gold through the mutual fund route)