Oil Economy

Recent U.S. sanctions on Russian energy and renewed engagement with Venezuelan oil reflect growing concerns over de-dollarisation and shifts in global oil-financial power from the Petrodollar System.

About the Petrodollar System

• The petrodollar system refers to the global practice of pricing and settling international oil trade primarily in U.S. dollars.

• This system has linked energy markets with global finance, making oil not just a commodity but a pillar of international monetary power.
• Origin: The system emerged in the early 1970s after the collapse of the Bretton Woods system.
  • Following negotiations between the United States and Saudi Arabia, oil-exporting countries agreed to price crude oil exclusively in U.S. dollars in exchange for American security guarantees and financial access.
  • This arrangement soon became the global norm through the Organization of the Petroleum Exporting Countries (OPEC).
• Current Use: Even today, a large share of global oil trade is settled in dollars, sustaining constant international demand for the U.S. currency. 
  • Globally, around 80% of oil trade remains in dollars  allowing  the United States to finance large fiscal and current account deficits and exercise geopolitical influence through sanctions and financial controls.

Current Scenario in the Global Oil Market

The global oil market is undergoing significant structural changes driven by geopolitics, technology, and energy transition.

• Geopolitical Fragmentation: Fragmentation has intensified after the Russia–Ukraine conflict.
  • Western sanctions on Russian oil disrupted traditional supply chains, forcing buyers such as India and China to seek discounted crude through alternative settlement mechanisms.
• Changes in Oil Quality :  The oil quality is reshaping trade flows. 
  • The United States produces mainly light sweet shale oil, while many of its refineries are designed for heavy sour crude. 
  • This explains continued U.S. interest in Venezuelan and Canadian oil despite energy abundance.
• Market Volatility: Supply uncertainty has increased due to conflicts in West Asia, OPEC+ production decisions, and climate-related disruptions.
  • These factors have made oil markets more politically sensitive.
• Energy Transition: Recent focus on non-fossils energy sources is altering long-term demand expectations.
  • Rapid growth in electric vehicles, especially in China, is gradually weakening future oil demand growth while simultaneously shifting industrial and technological leadership.
• Greater State Intervention: With governments using strategic reserves, export controls, and sanctions to influence markets, reducing the role of purely market-driven price discovery.

De-dollarisation of Oil Economy 

The dominance of the petrodollar is increasingly being questioned due to multiple coordinated and uncoordinated global developments.

• Non-dollar Oil Trade by Major Economies:  Russia has increasingly accepted payments in rubles and yuan for its oil exports following Western sanctions.
  • China has expanded yuan-denominated oil contracts, particularly with Russia and some Gulf suppliers.
• BRICS-led Financial Initiatives: BRICS nations have discussed alternative payment systems, local currency trade, and even a potential common settlement mechanism to reduce dependence on the U.S. dollar.
• Bilateral Currency Arrangements: India has experimented with non-dollar mechanisms for settling oil imports, including rupee-based trade frameworks and third-currency settlements, particularly for discounted Russian crude.
  • The Reserve Bank of India (RBI) established a formal framework for international trade settlement in INR in July 2022.
  • This is also a step towards Internationalisation of Indian Rupee.
• Weaponisation of the Dollar through Sanctions: Extensive U.S. use of financial sanctions against Iran, Russia, and Venezuela has incentivised countries to build parallel payment systems such as China’s Cross-Border Interbank Payment System (CIPS).
• Rise of Multipolar Energy Markets: The diversification of oil suppliers, growth of spot markets, and regional energy hubs are weakening the monopoly of any single currency in oil trade.

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Conclusion

The petrodollar system is gradually weakening amid geopolitical fragmentation, de-dollarisation efforts, and energy transition, with oil increasingly shaped by currency politics as much as by market fundamentals.

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