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Petroleum Producing Countries and Recycling of the Petrodollar

Updated on January 20, 2018
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John has been interested in economics and politics since high school. He wants to vote more responsibly and watches candidates' positions.

Pumpjack pumping an oil well near Lubbock, Texas
Pumpjack pumping an oil well near Lubbock, Texas | Source

The Effects of Trading Oil Only in U.S. Dollars - Petrodollar Warfare?

The term petrodollar is one that is used quite often in the media, still many people have no idea as to exactly what this term really means. Simply put, a petrodollar is the money which an oil producing nation receives for selling their oil. This term is used mainly to refer to the dollars that the countries in OPEC (Organization of Petroleum Exporting Countries) receive for exporting their petroleum as part of the global oil trade. OPEC is an international organization consisting of twelve oil exporting countries- Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela- who help determine the price of oil and control the majority of the worlds oil supply. In 1973, the United States and Saudi Arabia came to an agreement to trade oil in dollars, and by 1975 all OPEC countries had adopted a similar strategy, resulting in the rise of the petrodollar system.

Bakken Reservoir fields in Williston Basin
Bakken Reservoir fields in Williston Basin | Source

Petrodollars - A Two-Pronged Effect

You may often hear about the recycling of petrodollars and how much of an impact this has on the economy of the United States. In order to understand the impact that this recycling has, it is necessary to understand that the US dollar is the primary currency used in the global oil trade. This is important because it means that US dollars are constantly being used whenever oil is bought or sold, which has had the effect of partially, and some would say artificially, propping up the US economy. The media often refers to the recycling of petrodollars because not only are dollars used to purchase oil, but also because many petroleum exporters actually take the dollars they receive and deposit them back into banks in the United States, which further helps the US economy and allows many of the dollars spent on oil to remain within the country. Another major factor of petrodollar recycling is that when this money from petroleum is deposited in foreign banks, these banks then loan it to developing countries that are in debt because of their need to import oil. This loaned oil money is then sent directly back to the OPEC countries because the developing countries use their loans to purchase more oil and other goods. This pushes the developing countries further into debt and allows the foreign countries to grow stronger as they are basically loaning their own money to countries to be sent directly back.

This relationship between oil and the US dollar has long had the effect of keeping the value of the US dollar much higher than it would otherwise be. Even when the dollar is devalued and the US economy is in a downturn, petrodollars still allow the currency to stay at a much higher rate. However, there is one main problem associated with this, and that is inflation. As the price of oil rises, the countries who took loans from the IMF (which were lent to them by OPEC countries) will have a harder and harder time repaying these debts, while still needing even more money if they wish to continue to import oil to keep their country and economy running. This means that these oil exporters can basically control other economies that are dependent on their petroleum by inflating the price of oil. Petrodollar recycling is basically having the effect of forcing oil importing countries to fall further and further into debt. Eventually this system will become untenable for these smaller oil importing countries, and even for larger ones including the United States.

Petrodollar inflows (big ones) into a country often impact developed countries in a positive fashion. An increase of 10% in the price of oil increases the loon (Canadian dollar coin) value versus the US dollar by 3%.

Another major problem in the petrodollar system is slowly being created by Iran and Iranian petroleum. Iran is constantly one of the top four oil producers in the world, and is slowly looking to move away from the petrodollar system, as they believe the dollar to be worthless and artificially valued. In fact, Iran is now starting to accept other currencies for their oil, which could have a devastating effect on the US economy and the value of the dollar. If other OPEC countries decide to follow Irans lead and move away from using dollars for the global oil trade, then the value of the dollar could drop dramatically almost overnight. This would be destructive for the value of the US dollar since it is intrinsically tied up in the global oil trade and the price of petroleum. This is why many people are worried about the effect that Iranian petroleum could have on the US economy, and some have gone as far as to state that Iran is waging an economic war on the United States. As of right now, there is no sign that OPEC will completely move away from the petrodollar system in the near future, still it is a situation to pay close attention to.

An oil refinery in Mina-Al-Ahmadi, Kuwait
An oil refinery in Mina-Al-Ahmadi, Kuwait | Source

The Price of Oil

As of 6/24/2013, do you think the price of oil will be going up over the summer?

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A diagram of a pumpjack
A diagram of a pumpjack | Source

© 2012 John R Wilsdon

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