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Oil heads east – petrodollar goes south

Image: Maasmondmaritime

It was supposed to be the competition of the year.  Who was going to get to oversee the issue of shares in Saudi Arabia’s state oil company Aramco?

Early in the year, all eyes were on the City of London, with its centuries of experience.  Next, concerns about Brexit led to interest in London’s potential successors as the European banking centre – Frankfurt, Paris or Dublin.  Then Trump tweeted his way into the competition, insisting that Wall Street oversee the deal.

Then silence.

In early November, we saw why.  Mohammed bin Salman, the heir to the Saudi throne launched a palace coup to overthrow the various vested interests within the Saudi ruling elite:

“Over the weekend, Saudi police arrested an astonishing 11 princes, along with dozens of other officials and businessmen, at the direction of bin Salman and his father, King Salman. Nominally, the arrests are part of an anti-corruption drive spearheaded by the prince, widely known as MBS, but many experts say what’s really happening is the crown prince and heir to the throne jailing potential rivals to cement his own power.”

What, though, was bin Salman planning to do with his newfound power?

One answer is to be found in the export of Saudi Arabian oil.  The USA and Europe are no longer the main buyers of Saudi oil.  While the USA still imports 1.05 million barrels a day (mbd) from the Kingdom, this is dwarfed by the flows to Asia – Japan imports 1.26 mbd, China 1.03, South Korea 0.89 and India 0.73.  The future of what remains of Saudi Arabia’s oil is in the East, not the West.

The direction in which this may be heading is outlined by Sarah McFarlane, Summer Said and Mayumi Negishi in the Wall Street Journal:

“Saudi Arabian Oil Co., or Aramco, was slated to become the world’s largest-ever public offering, with a domestic and international listing next year. More recently, Riyadh has instead considered selling a private placement to a Chinese consortium of state-held entities, people familiar with the matter said…

“China is the world’s top oil importer and is looking to secure a steady supply of crude as its economy continues to race ahead. Aramco holds around 16% of the world’s proven crude reserves and is one of the biggest oil exporters.”

Underpinning this shift is the USA’s growing list of military failures in the Middle East; and especially the USA’s inability to prevent Russia successfully coming to the aid of its Syrian ally in its struggle to defeat the various occupying terror groups.

While many commentators believe that most US wars of intervention are to do with securing oil supplies, this is simplistic. The USA’s wars of intervention are about protecting the dollar’s status as the world’s reserve currency.  That status is underpinned by the 1974 deal with Saudi Arabia – then the world’s biggest oil producer – to ensure that the world’s oil would be traded solely in dollars.  The quid pro quo was that the US military would guarantee Saudi Arabia.

For an oil-based industrial world, it is impossible to overstate the value of this deal to the USA.  Every nation on earth has need for oil.  Since to obtain oil, every country must first obtain dollars, every country must trade with the USA; no matter how unfavourable the terms.  For developing countries like, say, Persia (Iran), Iraq, Libya, Venezuela or Nicaragua the terms were particularly pernicious.  Unable to trade, they were obliged to borrow (at high interest).  But they seldom got the dollars directly.  Most often, the dollars would be funnelled into the coffers of the western multinationals that specialise in infrastructure development.  The elites within those states enjoyed a share of the money; the masses got to pay for it all through their taxes.  Thus, the petrodollar has acted as a wealth transfer pump in which the real wealth of developing countries has been exchanged for green pieces of paper that the US Federal Reserve Bank can print out of thin air.

Understandably, elites in the developing countries were often overthrown.  Occasionally, the new leaders (Chavez, Gaddafi, Hussein, etc.) would seek to escape the clutches of the USA by trading their oil for gold or for an alternative currency like the Euro or the Yuan.  This, of course, is why leaders like Chavez, Gaddafi and Hussein are no longer with us while despots like Mugabe – who happily used the US dollar – got to abuse their people for decades.  Incidentally, it is also why Kim Jong Il has drawn the conclusion that the best way to sit down with the USA is with a nuclear arsenal at your back.

If the USA were to lose the petrodollar, it would quickly thereafter lose the dollar’s reserve currency status too.  In effect, the USA would lose its ability to swap fiat currency for goods.  Instead, the USA would have to return to trading goods for goods – something that, despite Trump’s promises to the contrary, is unlikely to happen on anything like the scale needed.  The reality is that all of the manufacturing that the US in particular and the West in general shipped off to Asia in search of cheap labour and little regulation has gone forever.  Rather like the UK in the wake of Brexit, the USA will suffer a currency devaluation in the event that the world begins to trade oil in whatever currency best suits it; particularly since a weakened US military looks powerless to prevent it this time around.

It is still possible that Saudi Arabia will relent and turn its face westward once again.  However, the other part of Mohammed bin Salman plans is the development of Saudi Arabia’s infrastructure for the post-oil future.  OPEC reporting is notoriously unreliable, and many western academics argue that the Kingdom’s production has already peaked.  So Saudi Arabia – like Norway – is looking to construct a raft of renewable and nuclear generating plants; not out of any concern for the environment, but to ensure that what remains of the oil will be available for export rather than being wasted on domestic consumption.

As the UK government knows all too well, if you want to build new infrastructure, China is the only partner in town.  Indeed, China has been building infrastructure throughout Asia, Africa, the Middle East and Europe even as the USA has squandered the last of its capital on a military-industrial complex that is long past its sell-by date.  If Saudi Arabia is seriously considering selling parts of its oil industry to the Chinese, it is because China is the only state with the means to build the infrastructure it needs.

The bonds between Saudi Arabia and the USA are still strong – The Kingdom was Trump’s first port of call on becoming president.  It is still possible that the Aramco sale will be overseen by Wall Street (although this would not prevent the Chinese buying the shares).  However, the fact that Saudi Arabia is even considering a private deal with China suggests that 2018 could be the year the global economy finally turns east.

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