OPEC+ Output Cut: The Bigger Picture

There’s most assuredly a tie in between the naked politicization of the world’s most financialized commodity and various “new world order” macro narratives. Considering the popularity of such narratives in 2022, and particularly the extent to which they’re inspired by realignments associated with the war in Ukraine and the implications for commodities in a world bedeviled by inflation, it’s important to consider the angles.

OPEC+’s “shock” decision to curb output by two million barrels per day was a transparent bid to buoy prices. Nigerian Minister of State for Petroleum Resources, Timipre Sylva, was forthcoming about that. But the geostrategic overtones were just as obvious. The alliance between Riyadh and Moscow is strengthening, and the production cuts were a message to Joe Biden. But there’s much more to this story than the proximity of the cuts to a proposed price cap on Russian crude and the US midterm elections.

Vladimir Putin and Mohamed Bin Salman are brothers in autocracy and make a good celebrity couple at summits, but the relationship is more nuanced than Thursday’s headlines would have you believe. The Kremlin has a staunch military ally in Tehran, home of Riyadh’s sworn sectarian adversary and the source of an enduring threat to Saudi oil infrastructure. It was, almost surely, the late Qassem Soleimani who orchestrated the brazen attacks on Abqaiq and Khurais in 2019, and it was also Soleimani who convinced Putin to intervene directly in Syria in 2015, when Russia moved to prop up the Assad regime. Some anti-Assad elements were backed by the Sunni powers, covertly or otherwise. There are no conspiracy theories in any of that. It’s all factual, and it’s all been reported in one way or another by mainstream Western media outlets.

Mediators are currently working to organize a sixth round of talks aimed at restoring diplomatic ties between Riyadh and Tehran, but the arrest of an Iranian national three months ago by the Saudis underscored how delicate the issues really are. The detention of Hajj pilgrim Khalil Dardmand followed the extremely ill-advised tweet shown below.

That’s Soleimani there on the phone. And that’s the Kaaba in the background. And that’s a good way to get yourself arrested. Dardmand returned to Iran this week.

The bottom line: Iran is the other pole in a bipolar Mideast power struggle and fights the Saudis, usually through its proxy in Yemen. At the same time, Iran is “team China,” as it were, in the new global bipolarity defined by a power struggle between Washington and Beijing. Russia is on that same team, and fought alongside Iran’s Lebanese proxy to restore the Assad government in Syria. There’s a tension there, and no amount of oil cooperation will be sufficient to overcome it completely. But, if Riyadh and Tehran can put aside eternal sectarian strife for the purposes of coordination on crude prices, then Moscow’s alliance with Tehran is no impediment either.

The risk is that Riyadh increasingly aligns itself with the China bipolarity bloc by, say, pricing its oil in yuan. But that brings us neatly to one of several problems with the “OPEC+ takes on the West” narrative, to quote the title of Goldman’s OPEC recap. There’s something entirely farcical about the idea of “taking on the West” by attempting to leverage a commodity that’s bought and sold almost exclusively under the US dollar hegemony umbrella. Russia this year discovered how tenuous it is to assume G7 claims accumulated in part through the sale of dollar- and euro-denominated energy are safe. They’re not. They can be frozen and seized. For the Saudis, the situation is arguably even more vexing. They run a currency peg, and their entire economic reality is constructed around the petrodollar. The idea of “taking on” Washington from that position is ludicrous.

Politically, the Beijing pivot is tougher for Riyadh than it is for Moscow, mostly due to the Kingdom’s long-running security alliance with Washington, but also because China is steadfast in its support of Iran in most geopolitical matters.

All of this is becoming more salient by the week. At least in terms of coordination and the sheer number of measures adopted, the Western sanctions regime to punish Putin for the conflict in Ukraine makes America’s diplomatic and economic blockade of Iran look like high school detention. According to Castellum, there are now 12,462 sanctions on Putin’s Russia. That figure for Iran is “just” 3,709. Saudi Arabia and China, both authoritarian states with poor human rights records and increasingly contentious relationships with the West, are doubtlessly concerned about their own situation given that both have very large USD reserves.

With all of that in mind, and in light of the OPEC+ decision and all the associated commentary circulating on Thursday, I wanted to recycle the first section of an article published here in March called “The Petroyuan And ApeCoin: Fables Of The Dollar Deconstruction.” What follows are excerpts from that piece.

Talks around yuan-priced crude have been going on for at least a half-dozen years, and to the extent they’ve taken on a new sense of urgency, it’s primarily due to frustration in Riyadh with US security commitments.

The Biden administration isn’t as friendly with Bin Salman as the Trump administration was, nor is this White House as hawkish on Iran as the last. Notwithstanding ongoing talks to restore ties, Riyadh and Tehran haven’t had diplomatic relations since the Kingdom’s decision to execute a prominent Shiite cleric in 2016 pushed the regional rivals to brink of war. Ongoing attacks by the IRGC-backed Houthis against Saudi infrastructure are a constant reminder of simmering tensions, and although the US assassination of Soleimani likely degraded Iran’s willingness and capacity to orchestrate spectacular strikes against high profile targets à la Abqaiq and Khurais, the Kingdom’s security demands of Washington aren’t always commensurate with the perceived scope of sundry threats. In short: There’s no such thing as “too much” when it comes to security guarantees. If the US wants more oil, the Kingdom wants more security.

Ideally, Bin Salman would also like carte blanche to perpetrate the war in Yemen, not just unbothered by allegations of war crimes, but in fact abetted by US complicity. He’d also rather not be lectured by anyone in Washington when he presides over extraterritorial executions (i.e., Jamal Khashoggi’s demise in the Kingdom’s Istanbul consulate), let alone be sued for them.

That’s the price of the petrodollar, but this is a classic case where one side’s leverage disappears entirely in the most extreme scenarios. As long as the world is generally stable and ties between Washington and Riyadh are even a semblance of friendly, the Saudis have leverage. But in the (highly unlikely) event the relationship breaks down entirely, the US doesn’t actually need Saudi Arabia. Washington could cut the Kingdom loose tomorrow, and the vast majority of the global commodities trade would still be conducted in dollars and Americans would still have energy. The Saudis, on the other hand, would be compelled to reckon with a number of existential problems virtually overnight, including, but not limited to, a currency crisis, social unrest tied to inevitable economic upheaval and something much closer to even odds (militarily) against the IRGC.

When you consider the petroyuan discussion, you need to take account of everything said above. Note that Beijing and Tehran are strategic allies. The Saudis can’t depend on China to protect them from Iranian aggression. No amount of oil sales are sufficient to flip that equation, especially not when Iran sells oil too.

With that out of the way, there are myriad other reasons why the petroyuan story is just that — a story. It’s a canard, and a tired one at that. If you want to know how tired, consider that many of you have almost surely read something I’ve written on it before, and not in my current incarnation. That is: Some of my petroyuan musings were available to the public prior to the advent of this site.

True, six years isn’t a long time in the grand scheme of things, but the fact that some readers have unknowingly perused my opinion on this when Barack Obama was still in the Oval Office speaks to the “here we go again” nature of the petroyuan headline. As Bloomberg’s Cameron Crise wrote, “The headline that Saudi Arabia might accept yuan for its oil exports to China is a nice story that fits the current geopolitical narrative about the dismemberment of the current global financial order — such a nice story, in fact, that various iterations have floated around in 2017, 2018, 2019, 2020 and last year.”

So, it’s old news. But why can’t it work? Well, let me count the reasons. Most obviously, the riyal is pegged to the dollar, which means, among other things, that embarking down a policy path aimed at undermining the greenback is tantamount to pulling out a pistol, waving it around wildly and then shooting yourself in the foot. Additionally, just about the last thing you want to do when you preside over an isolated, one-dimensional economy where the currency is pegged to the dollar is start selling your most important export for something other than dollars. If it became obvious that the monarchy was bent on pursuing such a financial suicide mission, the market would start to doubt the durability of the peg.

Far be it from me to question the wisdom of Zoltan Pozsar, but consider me skeptical of the idea that, as he wrote in March, the PBoC could print yuan, buy Russian commodities and thereby establish a “Eurorenminbi,” which Pozsar suggested would mark “China’s first real step to break the hegemony of the Eurodollar market.” For one thing, nobody sane wants to see the demise of the Eurodollar market, because that would mean the demise of… well, everything, really. Global commerce and finance as we know it would cease to exist. The world would stop spinning. Almost literally, if you conceptualize of international finance and trade as goods and services circling the globe.

Beyond that, though, who, other than a desperate autocrat in Moscow, would willingly cede control of their financial future to Beijing? If you get into the yuan in size, it’s not so easy to get out. What happens to Riyadh’s CNY assets if, for example, Iran decides to start a war with the Saudis? Unlikely if the two were to restore diplomatic ties, but certainly not out of the question. The Mideast isn’t exactly known for stability and sectarian tensions are famously intractable. If you think the White House is capricious, wait until you see what happens to a nation’s CNY assets in the event that nation ends up in a hot war with one of Beijing’s staunchest international allies.

And there’s more. Given the realities of the dollar peg, any oil sales the Saudis made in yuan would probably just end up being converted back into dollars, in which case the entire endeavor would amount to little more than a circuitous charade. If the Saudis were to keep their CNY proceeds, what exactly are they going to do with them? Buy Chinese government bonds? Maybe. But that’s not straightforward either. Consider the following from Bloomberg’s Crise:

Looking at Saudi Arabia’s trade balance with China, we see that it was a surplus of roughly 20 billion yuan per month towards the end of last year. It seems reasonable to think that the total should exceed 200 billion yuan pretty easily given trends in oil prices. There are approximately 27 trillion yuan of central government bonds, so net Saudi yuan proceeds would amount to a little less than 1% of that per year. That sounds feasible, right? It seems like it, until you consider that according to Bloomberg data, the 50 largest institutional holders of government bonds — which include a lot of domestic asset managers — hold a total of just over 700 billion yuan of bonds. The Saudis could conceivably match that in less than four years. Having lots of demand for your bonds seems like a nice problem to have, but a problem it will be if there isn’t enough paper for domestic banks and investors. So the question remains: Would China be prepared to ramp up government debt and conceivably see the economy shift to a current account deficit if that’s the price required for an internationally-accepted petroyuan?

Good question. And one that speaks directly to the notion that fanciful headlines usually aren’t compatible with reality. The petroyuan story is no exception.

In a March 16 note which carried the hilarious title “Lost Rents of Arabia,” Rabobank’s Michael Every further underscored how absurd this probably is from a logistical perspective. “We’re talking $56 billion in oil and related petrochemical exports, and $27 billion in Saudi imports, taking 2019 as a base,” he wrote, on the way to noting that “$56 billion is hardly the entire $2.6 trillion global oil market, even if this is Saudi Arabia, and even if we assume all Saudi-China trade switches to CNY, that’s $320 million per working day versus the $6.6 trillion global daily FX market, and note I’m using dollars not CNY for easy comprehension here, which makes my point for me.”

That latter quip speaks to a point I’m compelled to reiterate virtually every, single day. Anytime anyone starts talking about the demise of dollar hegemony, virtually every argument that involves numbers is couched in dollar terms, an irony that’s perpetually lost on the people making the argument.

Rabo’s Every went further. “The oil market needs a base currency that’s liquid, which CNY is not, freely tradable, which CNY is not, and stable, which CNY only is because it doesn’t meet the other two criteria, and because it’s on/off soft-pegged to the US dollar,” he wrote, citing an incisive critique from Anas Alhajji, on the way to noting that,

Even a move to oil priced in a basket of currencies is hugely complex to maintain across OPEC partners, which is why it hasn’t happened yet. Saudi Arabia’s own currency is pegged to the US dollar, so it would be exchanging complete shielding from FX volatility for FX volatility, unless CNY also remains pegged to the US dollar. Saudi Arabia would end up accumulating lots of CNY, which is of no use unless everyone else makes the same shift, and CNY does not meet the criteria to expand from its current base. Indeed, with China being accused of perhaps helping Russia militarily in Ukraine, there won’t be any Western adoption of CNY. Perhaps emerging markets will do so, but that bloc would then gradually, or rapidly, detach from the US and the West. Good luck with that. Saudi Arabia would probably still price oil in dollars given its own balance sheet, and just allow (some) Chinese oil payment in CNY and the Saudis would then sell those CNY back to China for dollars immediately.

Note how all of this ends up being self-referential at every, single turn. The entire world is priced in dollars. Love it, hate it or apathetic to it, you can’t escape it.


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5 thoughts on “OPEC+ Output Cut: The Bigger Picture

  1. The timing of this cut in relationship to the midterms should be disturbing to anyone involved in American government. Should is naive I know, this will of course be blamed on Biden when gas prices rise again by the same folks that blame him (and all Democrats) for everything that isn’t right in the US. However, as you have stated, there are many tools available to the Biden admin to combat this attack on global oil prices and he should lever those very publicly to ensure that accountability lies with those who are responsible.

    The dollar dominance noted in this article has had me thinking a lot lately about currency globally and the repeated improper reporting of the dollar’s demise. I have seen these headlines pop up for over a decade, blaming the ever growing national debt on why in the very near future the dollar will no longer be the global reserve currency. I think the past couple of weeks have shed a lot of light on how preposterous that thinking is. While the debt is very high in the US and, inflation whether attributable to that debt or not, is out of control; the dollar is dominating every single other currency on the planet with ease. This seems to illustrate the isolationary view we American’s tend to take towards everything including economics. Sure, the debt is growing and higher than it has ever been, what about other national debts though? Do we even think or report on how their government’s are handling currency and debt? Not really. So with an isolationist viewpoint on currency and the economy it becomes easier to sell the idea that higher US national debt will ultimately lead to the unwinding of dollar dominance. Nothing is ever that simple.

  2. Excellent rigorous analysis Mr H. Its clear that no fiat currency can can come close to replacing the hegemony of the petrodollar. And the Saudis would rather wait for a friendlier Republican administration than try to experiment with any other fiat currency to disturb the petrodollar regime. However, is there a case to be made for gold as a non-fiat store of wealth and medium of exchange that would be more “neutral” than any fiat currency ?? I would be interested in a similarly rigorous analysis of why gold, if adopted and demanded as a medium of exchange by OPEC nations would not have the ability to threaten the hegemony of the petrodollar. Certainly gold eclipses the yuan or euro as reliable store of value. Thanks again for the prolific output of excellent articles the past few days.

  3. Thoughtfully written and well-researched; I do love your macro think pieces.

    A theme you have visited before is that de-dollarization happens at a glacial base. Poszar et Al are perpetually crying wolf (maybe not Poszar for too long; he has a day job which should be thrown into sharp relief against his hobby thesis the moment the next liquidity crisis hits).

    I would love to hear H’s thoughts on what an earnest dollar slide WOULD look like! What might the catalysts be, and on what time frame would they ply out?

    That’s probably asking the impossible of you; your talent is for tuning into the zeitgeist and integrating the geopolitical with the economic.

    Nevertheless: even conceding that all crystal balls re bunk, I’d be interested to hear your thoughts on a hypothetical emergence of a new world order, if ever you have any to share.

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