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Opinion

Oil -- bold Asian bids to dent dollar dominance

Plans for trading in alternative currencies fraught with challenges

Indonesia has made an unusually bold move in its battle to stem foreign exchange outflows. In late October, state-owned oil company Pertamina asked its suppliers of diesel and crude to stop charging in dollars and instead choose the rupiah, or go for the euro, Chinese yuan, Japanese yen or Saudi riyal.

Jakarta hopes that as many suppliers as possible will opt for the rupiah to relieve the pressure on the currency, which has dropped to 20-year lows against the U.S. dollar. But even switching to the euro and other foreign currencies helps because the dollar has strengthened the most this year.

Benchmark Brent crude prices, denominated in U.S. dollars, have jumped 17% year-to-date but in rupiah terms they have spiked by more than 31% due to a steady slide in the Indonesian currency.

India, whose currency the rupee has tanked to historic lows against the dollar, is in the same boat.

Prime Minister Narendra Modi recently made a strong pitch to Middle Eastern oil producers to consider accepting rupee payment for their crude exports to India.

In a mid-October meeting in New Delhi with Saudi Energy Minister Khalid Al-Falih and CEO of the UAE's Abu Dhabi National Oil Co., Sultan Ahmed Al Jaber, Modi argued that buying crude in rupees would help relieve the strain on India's fiscal deficit, which has been worsening due to rising oil prices and a sharp depreciation of the rupee.

Modi's argument was certainly compelling from the perspective of India and other importers. But how the visiting Saudi energy minister reacted to the proposal is not known. Nothing suggests that Riyadh and other exporters will rush to switch to rupees. And while Indonesia's suppliers will have to pick one of the currencies being offered instead of the dollar, they are likely to pass on the cost of their exchange rate risk to Pertamina in the form of higher prices.

The double whammy of rising crude prices and weaker buying power due to depreciating currencies is being felt acutely among the emerging economies that are heavily dependent on oil imports.

With the U.S. Federal Reserve set to continue hiking interest rates and not much downside seen for crude prices amid geopolitical tensions and a tight supply-demand balance, Indonesia and other net importers see little hope for relief in their ballooning import expenditure on crude and refined products.

China, the world's largest crude importer, saw its currency, the yuan, sink to 21-month lows in October against the U.S. dollar amid growing fears over its economic growth. Smaller Asian countries, from Pakistan to the Philippines and Sri Lanka, are also struggling with weak currencies and inflated oil import bills, as is India, where the rupee is at all-time lows against the dollar and oil prices have risen 38% this year.

The U.S. dollar and crude prices have been historically inversely correlated, which has tended to mitigate the impact of high oil prices for consumers, but that relationship occasionally breaks down, as in the past several months.

Efforts to topple the U.S. currency in oil trade have been gathering momentum in recent years, and not only out of foreign exchange concerns.

Geopolitical tensions and the shared desire among some countries to end what they see as U.S. hegemony over the oil market have been chipping away the dollar's dominance for the past few years.

Iran accepted the yuan, the rupee, the yen and the won for its crude sales to China, India, Japan and South Korea during the last round of multilateral nuclear sanctions against Tehran in 2011-15, which locked it out of the dollar payment system. Iran and its buyers are looking to adopt the same workaround when new U.S. sanctions against the producer's oil and shipping sectors take effect from Nov. 5.

Russia and China, both of which are keen to replace the dollar as the world's dominant reserve currency, signed two major 30-year natural gas supply agreements in 2014 involving payment in yuan and Russian rubles. China pays for some of its crude from Russia with yuan.

When China launched its much-awaited crude futures contract on the Shanghai exchange in March this year, it denominated it in yuan, rejecting suggestions from market experts to price it in U.S. dollars to boost its chances of becoming a regional pricing benchmark.

The move was in line with Beijing's push to internationalize the yuan and was seen as a precursor to China pressuring Saudi Arabia and possibly other major crude suppliers in the Middle East to accept yuan payment. The Shanghai crude futures contract has had mixed success; its adoption as a benchmark still appears to be a distant dream.

Venezuela, an OPEC producer battling eye-popping inflation and currency depreciation, has been trying unsuccessfully since December to coax Asian crude buyers to pay with the "Petro," its own cryptocurrency backed by the country's oil reserves.

For Middle Eastern crude producers, heavily reliant on oil revenues, moving away from the dollar-based pricing and payment system of the past seven decades is risky. Under a 1973 agreement with Washington, Saudi Arabia promised to price all its oil in U.S. dollars, in return for U.S. arms and security guarantees. Saudi Arabia, the UAE, Kuwait, Qatar and Oman, the oil-rich members of the Gulf Cooperation Council, have pegged their currencies to the greenback.

The looming U.S. sanctions against Iran have spurred the European Union to consider paying the country in euros. Although that would bypass the U.S. financial system, European companies are expected to steer clear of doing business with Iran for fear of attracting U.S. sanctions. That stymies what might have been an opportunity for the euro to become a credible challenger to the U.S. dollar in the world of oil.

Crude oil is a global commodity, best traded in a fully-convertible currency. While the dollar has rivals on that score, the oil market ecosystem is dollar-based, with benchmark crude futures contracts on exchanges in Dubai, London and New York traded and settled in U.S. dollars. Splitting price discovery and payment currencies would mean forcing buyers and sellers to assume foreign exchange risk.

If the alternative currency is not fully convertible, like the rupee or the rupiah, oil suppliers accepting it would be essentially signing up for a barter system, using the buyer's currency to buy goods from that country. An Iran under sanctions would agree to such an arrangement, but its Middle Eastern peers are not under any pressure to do so.

Although it is hard to envision the unified dollar-based market giving way to alternatives any time soon, the pressure for change will not go away, especially from states with rising oil import needs and growing fiscal deficits, as well as those with difficult relations with Washington. The dollar's dominance is not about to collapse. But it has begun crumbling at the edges.

Vandana Hari is founder of Singapore-based Vanda Insights, which tracks energy markets. She has two decades of experience providing essential intelligence on the energy sector.

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