Mike Dolan: The ROI-Gulf War rattles the petrodollar Foundations

No matter what the outcome of this war is, the question for the Gulf's oil-rich economies will remain: "Is the U.S. umbrella worth the cost?" Since U.S., Israel and other countries launched attacks on Iran, on February 28, the Gulf's neighbours have been the most affected by the missiles and drones which followed. These weapons destroyed energy infrastructure and damaged economies. They also exposed the limits of a supposed U.S. umbrella.

This reckoning has consequences that go 'far beyond the militaristic. The issue is the potential rethinking of the "financial" and "trade" ties that are at the core of their dollar-based economy, as well as the hundreds of millions of dollars in dollar reserves.

PETRODOLLAR BARGAINS

Washington and Gulf states have relied for decades on an implicit deal: U.S. security in exchange of access to Gulf oil, priced in dollars and the recycling hundreds of billions in those "petrodollars" windfalls into U.S. stocks, technology and bonds.

Since the 1970s, the arrangement has remained central to U.S. and Saudi relations.

The numbers that were built around this bargain speak for themselves. Saudi Arabia, Qatar, Oman, Bahrain, and the United Arab Emirates all tie their currencies to the US dollar. This requires large reserves, estimated at $800 billion.

The Gulf Cooperation Council sovereign wealth funds, which are estimated to manage $6 trillion in bonds, stocks and private equity, as well as other U.S. heavy investments, dwarf this figure.

Saudi Arabian and UAE funds are listed as the top 20 holders of Treasury Securities in the U.S. Treasury, with a combined value of almost $250 billion.

There are likely to be billions of dollars in other financial centres such as London and offshore havens.

Three Fault Lines

The petrodollar system is based on three pillars: the need for oil in America, the price of oil expressed in dollars, and the relationship between the Gulf region and Washington regarding security. All three are under pressure.

The United States is no longer a strict importer of Middle East oil.

The dollar price of oil had already begun to erode before the war. Since years, many countries, including China, Russia, and Iran, have tried to denominate the energy trade in their currencies. They have only had marginal success.

Third, and most importantly, the war has shaken the U.S. Security umbrella and Gulf trust in it.

PETRODOLLAR SWITCH

Jim O'Neill, former UK Treasury Minister and Goldman Sachs economist Jim O'Neill claims that the war may push GCC nations closer to China and India.

O'Neill wrote in an article earlier this month that "this war has demonstrated so far that allegiance to the U.S. does not guarantee security." The economic opportunities that Asia is offering are becoming more and more attractive.

These numbers confirm this view. According to a report by Deutsche Bank on Tuesday, Saudi Arabia sells four times more oil to China than it does to the U.S.

Mallika Sachdeva, a German strategist, argues that the petrodollar system was already under strain before the war. The majority of Middle East oil flows to Asia. Sanctioned Russian oil and Iranian oil were traded in non-dollar currencies. Saudi Arabia was localising its defense industry and was experimenting with nondollar oil payments.

The war may accelerate the process by destroying the security umbrella and forcing the liquidation dollar assets in order to cover economic damages across the Gulf.

THE LONGER GAME

Reorienting the world away from petrodollars and towards "petroyuan," or "petrorupee," or "petroeuro," pools is a more long-term, deeper issue.

If the global energy shock caused by?this war accelerates the shift away from fossil-fuels, the impact on the petrodollar could be even greater in the long term.

In its report, Deutsche Bank stated: "The importance of the Middle East in the role of the dollar as the reserve currency for the world should not be understated." The current conflict may test the foundations for the petrodollar system.

Oil tankers may be allowed to cross the 'Strait of Hormuz, which is currently blocked by the US, if they are paid in yuan. This has long-term implications for the markets.

Gulf investors are also being closely monitored to see if the war will end soon.

The opinions expressed are those of Mike Dolan a columnist at. This column is great! Check out Open Interest, your new essential source for global financial commentary. Follow ROI on LinkedIn and X. Listen to the Morning Bid podcast daily on Apple, Spotify or the app. Subscribe to the Morning Bid podcast and hear journalists discussing the latest news in finance and markets seven days a weeks.

(source: Reuters)