How Long the Dollar as World Currency?

BTL in a recent post, Anon asked for views on how much of the present ME unpleasantness is explained by US desire to maintain the dollar as the currency in which the world buys oil?   Anon went on to mention that Gaddafi head been mooting a barter scheme to circumvent dealing in dollars before his demise.

This is quite a long post so I'll summarise here: not really plausible, IMHO. 

It's not an academic response, nor does it contain any quantified macro-economics (my being in neither profession): but after a career in pragmatic multinational micro-economics - the energy business - I do have a number of practical observations.

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1.  Liquidity / critical mass is vital in every sector.  Nothing stymies business worse than non-fungibility and non-convertability.   Needless to say, if anything that has "currency" today is doing a halfway satisfactory job in the market, that militates strongly against the adoption of anything else.  The intertia / barriers to entry & exit are great.

2.  There have long been plenty of national-pride-based attempts to drag the commercial world away from Anglo-US dominance of the instruments of liquidity.  In my own sphere: many countries hate having their oil priced against Brent (which almost all crude oil is, except US production), let alone in dollars; and there have been attempts to establish marker-prices for other blends, and to have them traded in other financial centres.  Kuwait Blend; Urals Blend, Dubai ... they come along, they get reduced to a basis-differential against Brent, and the world carries on.  And this despite apparently formidable technical difficulties in maintaining "Brent" as a marker (due to terminally declining North Sea production).  But the clever chaps in London cunningly keep extending the definition of the blend and - thus far - they've had total success.

Likewise, and to Anon's question, lots of folks have dreamed of having oil - even just their own local production grades - priced in their own currencies.  You might justly argue that provided there is full FX convertability between those currencies and USD, what's to stop them?  Answer: nothing - except it would be entirely empty.  The whole business world speaks English (and reads the FT), not Russian or Mandarin.  Arbitrage ensures "their" price would always be (Brent USD +/- basis)*FX.

As regards barter schemes ... well, money was invented, partly because there are distinct, nay fatal limitations as to what barter can achieve.  So I don't think Gaddafi represented any kind of threat to dollar oil trade.   BTW, the Russians have tried to sell gas to China in complex packages with industrial equipment - but the Chinese are having none of it!  Cash on the nail, so far as they are concerned.

3.  Some things do change & evolve: but typically only for very good reasons (which do not include national pride).  Example: the first natural gas trading hub in Europe was the UK's "NBP", and European gas prices for many years were given as NBP (+/- basis).  How logical was this, when the UK isn't remotely the centre of gravity of European gas movements, and the Eu deals mostly in EUR?  Very logical indeed - when only the UK's gas market was truly liquid.  However, over time, unsurprisingly several other hubs emerged as the rest of the EU belatedly caught up on gas trading (well, sort-of), one of which - the Dutch TTF -  was very much closer to the continental centre of gravity than our peripheral island market.  A German hub would have been just as likely a candidate: but the Germans genuinely don't understand how markets work, and screwed up their market design.  The Dutch are much better at it: and so today the TTF is more usually given as reference point for "the gas price in Europe".  (By the way, NBP and TTF trade at incredibly high correlations and the basis differential is always easily rationalised - as you'd expect, because they are both liquid, and generally inter-connected physically.)

4.  So: given that things can change over time and with good fundamental reasons, who's to rule out everything coming under Chinese hegemony in the long run, when their economy becomes dominant?  Well, in the very long run, maybe.  But right now they don't really understand markets either, nor indeed quite How The World Works.  Case in point: they'd spent years cultivating Gaddafi (for his oil), and were gobsmacked when "the West" just did away with him one day.   WTF?, you could hear them saying.   And, to their disgust, right now large & mainstream Chinese firms are obliged to, errrr, kowtow to US sanctions on Iran, much as they'd like to exploit the situation commercially. 

Of course, they hate this stuff and have every intention of supplanting it.  One day.  And who knows, maybe Trump will so overplay his hand, he'll help them accelerate the process.

Then again, the French have long hated the use of the English language everywhere - and most specifically in the organs and councils of the EU.  Tough titty, mes braves; not even Brexit is going to change that. 

No lengthy post is complete without an army anecdote.  All army vehicles come with a comprehensive toolkit.  But as I quickly discovered when becoming responsible for a troop of 30 vehicles, there's only one item out of a dozen or so that's ever taken out of the box, and which is permanently going missing - the Spanner Adjustable.  

Yes: some things turn out to be Really Useful.  The English language, the Brent oil contract, and the Almighty USD are excellent examples.  The clever Chinese will need to come up with something even better if they want any of them to be superceded.

ND

Better policy needed for North Sea to stave of shutdown

The North Sea, the pot of Gold for Independent Scotland, is in the worst crisis since 2008/9. With Oil prices hovering around $50, the highest cost oil producing region in world in understandably in trouble.

Jobs are being lost and contracts are either not being renewed or cancelled. Several of the international oil majors are pulling out of the region and looking to sell their remaining fields.

Moreover, the Government Regulator is fixated on De-Commissioning costs, over and above the cost of production. Laughingly a couple of years ago Executives were wondering whether to buy older fields as they balanced the income against the decom cost to see whether there was any economic point in acquiring; it came up as a no surprisingly often.

However, this is still a significant chunk of UK industry and know-how. Yes, all those Scots can offski to Dubai and the Far East for lives of expat bliss, much as shipbuilders once did.

Is there a way though to actually keep the oil following for the next 10-15 years and make the most of what we have?

The answer must be yes, but will require more Government flexibility. One hit the Industry took was Osborne raising taxes in his first budget in 2010, when prices were still high. Now that prices are below cost, there needs to be a severe relaxation of the tax regime to encourage companies to stay in business. Gordon Brown had his much maligned fuel-price escalator....but there is a kernel of an idea there.

The world now moves much faster that it used to, business is connected and the markets are connected globally to a very highly-correlated extent. Government budgets and taxes are set on an annual basis - Companies don't like too much change because they want to plan expenditures.

For oil though, the biggest variable is the price of the product, over which the companies have no control - a bugger of a business. So why not get the Government to set moving tax thresholds set on a moveable price.  The difference to today, where the percentages are set (providing some market balance), would be that different tax thresholds would come into play over quarterly or bi-annual periods. When the price of oil was very low there would be negative taxes to ensure employment and the industry continued, made up for when prices were higher by higher bands. The next impact would be that cash flows for the North Sea companies would be more stable - but better than the huge breaks given to the fortunate few like Chevron and Maersk but not to the likes of Ithaca or Enquest.

Government needs to be more flexible in its approach, else a whole industry will be gone before we know it. Oil prices are going nowhere but down for the next few months and years maybe, so without action the North Atlantic shelf will not survive the competition from the US Shale boom - or indeed a growing potential UK shale boom.

Brent Oil Price Stuffed - In More Ways Than One?

CU was right to remind all us oil consumers, merrily watching the price cratering, that there is UK industry at stake in all this: and as 'Suffragent' said in the comments (previous post), there is an accelerator-factor at work.  The development of small fields depends heavily on their being able to blister onto the infrastructure already built for (and paid for by) much larger, older fields.  If the latter fall off the perch sooner, the former rapidy become uneconomic at any price.

It just occurred to me, as price and UK production fall, there may be another sector at risk.

That 70% of the world's crude (and maybe an even higher proportion of oil forward and futures) is denominated relative to 'Brent' is one of those miracles of the City of London that are easily forgotten.  As 'price marker' for so much global oil, the Brent field in the North Sea is way, way past its prime, and 'Brent' oil has been a blend from several fields for decades now.  When that blend started to decline in volume, output from the mighty Forties complex was included in nominal 'Brent'; and when that in turn started waning beyond the point where physical delivery could readily be made available to any forward-market punter who actually wanted some (a tiny minority, to be sure, but the principle is important), two major Norwegian blend were enlisted.  And still it declines.

It so happens that Brent's one-time deadly rival, WTI of the USA, has been in dreadful trouble for several years, and has completely lost it as regards being of global significance.  (We looked at this ages ago; and at Alphaville they once talked of little else.)  But there are other would-be rivals: it has always irked the Arabs and the Russians that Brent dominates their vast output: and there are plenty of trading folk in the Far East who reckon they merit a crack at the lucrative oil sector.

So the vast and valuable Brent-based London oil market needs to have a care.  Last time we worried about this, it was market integrity that exercised us.  It has to be said, however, that a never-to-be reversed collapse in North Sea production (UK, and in due course Norway + Denmark) couldn't help the cause one bit.

The chaps in the City don't need me to tell the all this.  Given that further decline in output was inevitable, they will have contingency plans.  Hopefully, they are good enough to cater for a rather unexpected acceleration in the process.

ND

Ukraine & the Price of Oil

A glance at the chart below is a vision of a dog that hasn't barked.  There's World War 3 brewing in Ukraine, and yet Brent has been even more tightly range-bound than the $100-120 we'd become accustomed to. 

What to say ?  Obviously no-one imagines Russia is about to stop selling oil, either to punish the West or as the result of an embargo.  Has the Invisible Hand decided that in the great scheme of things it is all just posturing on both sides, and that the annexation of Crimea is just small beer ?

We've noted several times on the QT compo how the BBC has resolutely downplayed the whole crisis.  Perhaps they take their lead from the Brent market when it come to foreign affairs.  Missing airliners, missing schoolgirls, and lurid murder trials seem to be what counts for top-headline foreign news coverage.

It's an interesting thought that Russia re-ordering the FSU might be a sideshow.  What's the main event, then - are we just all sitting around waiting for the Chinese economy to pop ?  Maybe Brent would be forced to notice that.

ND

Brent Market : Another British Interest to Defend

It's familiar enough to see oil quoted in terms of the price per barrel of Brent oil.  Perhaps less well-known, the price of Brent - a declining North Sea field - sets crude oil prices for around two-thirds of the world's oil and is the cornerstone of global financial oil trading, the forwards / futures / options markets, whether for hedging or speculation, arbitrage or market-making.  And so London rules the roost in global oil trading, which is a seriously big deal.  (A significant amount is OTC trade, so there are no definitive figures on how big.  But it's Very Big.)

That's despite a number of factors one could imagine working against it:

• the amount of actual Brent production is not very great any more
• the logistics of physically settling a Brent contract (i.e. actually taking delivery of a cargo of Brent) are pretty complex - the preserve of relatively few specialist energy companies and traders
• the financial aspects of Brent trade are unusually complex, too (relative to other paper-traded commodities)
• the long-time US price-setter - WTI (West Texas Intermediate) has a very aggressive lobby promoting it as the 'world's crude-oil price marker'
• several other countries around the world with strong prima facie cases believe they should be the home of important price-setting markets - hence Dubai Blend and Urals Blend etc.

source: wiki

All to no avail for the would-be usurpers: and as in so many areas of trade and finance, London rules supreme.  Despite its decades of preeminence the WTI is now a tub of guts, suffering over the last few years from even worse logistical problems than Brent.  With its congested inland delivery point, and although still much traded in N.America for essentially historical reasons (e.g. lots of long term contracts are indexed to it), the WTI index has become a parochial anachronism, reflective of not very much at all.  Local traders favour new Gulf Coast indices that are much more representative of world prices, but they don't yet have serious volume / liquidity.  And the rest of the world - well, the RoW don't really have what it takes to establish a global financial market.  Yet.

But it doesn't mean they won't keep trying, and weaknesses in the Brent set-up need to be addressed.  It has evolved successfully in several steps over the years, expanding the underlying physical base from just the Brent complex to Brent+Forties complex, then + Oseberg and + Ecofisk, all still broadly similar North Sea grades.  However they are all in deep decline; and there has to be at least some material physical base underpinning the settlement of derivatives (maybe not in theory, but certainly in practice).

So the legion commercial interests with a stake in the Brent market had better stay ahead of the curve when criticisms are once more leveled at the technical underpinnings.  Based on past successes in this regard they probably will, but complacency could be fatal.

The other weakness which needs addressing isn't technical, it's criminal.  Yes, Brent has been subject of index-rigging allegations: probably less serious than LIBOR, but infinitely more troubling than the UK gas index allegations.  Yet again I find myself advocating public castration for any proven perps.  

Yes folks, Brent is another of those vital markets which make London what it is.  We need it to stay that way.

ND