Oil and gas in the Capitals

Yes, 2022 was a great year for the Arab Gulf States, as high oil and LNG prices increased government revenues, generated large budget surpluses and contributed to some of the highest economic growth rates in the world. Political activities were on steroids: several world leaders, including President Biden and several European and Asian leaders, visited the region, while some of the most prestigious summits and conferences have or will be held there, including COP 27, which was held in Egypt and COP 28, which will be held in the United Arab Emirates (UAE). 

On Dec. 7, Chinese President Xi Jinping arrived in Saudi Arabia, where he met with top officials and attended the first China-GCC summit and the first Arab-Chinese summit in the kingdom.  Xi spoke of cooperation between his country and GCC states, saying China will maintain its oil imports from Gulf producers and will also expand imports of LNG, while bolstering cooperation in various energy projects. One thing is clear: Xi's visit was not about oil.  In addition, the Saudis do not want their oil policy to be part of the discussion. 

China is Saudi Arabia’s largest trading partner, and when it comes to oil specifically, the kingdom is officially China’s top supplier of crude oil. (However, counting the Russian oil laundering, Russia could be the largest supplier.) In 2022, Saudi Arabia exported an average of around 1.6 MMbpd of crude to China, similar to the rate of exports in 2021. Meanwhile, in a sign of growing Saudi-Chinese energy cooperation, Saudi Aramco and China's Shandong Energy Group, signed an MoU on Dec. 9 that includes a potential crude oil supply agreement and chemical products offtake agreement. 

For the Arab countries, especially in the Gulf, distancing China from Iran is a big win. Iranian leaders were furious at what was perceived as a betrayal by the Chinese leadership; the joint statement between the Gulf Cooperation Council and the Chinese made a reference to three small islands in the Persian Gulf that Iran annexed from the United Arab Emirates in 1971. Regardless, Chinese relations with the Iranian regime are strategic, and such a statement will not affect Iranian-Chinese relations. China will continue to import cheap Iranian crude, while it continues with its long-term infrastructure plan in the region. 

China’s leader called on countries in the Gulf region to use the Chinese yuan for oil and gas sales. He said China “will make full use of the Shanghai Petroleum and National Gas Exchange as a platform to carry out yuan settlement of oil and gas trade.” Although this may sound like a good idea, it is not practical. 

Non-dollar oil pricing and revenues demystified. Oil will continue to be priced in U.S. dollars for several reasons, including:

1. To price oil in any currency, that currency has to have three characteristics: liquidity, relative stability, and worldwide acceptance. The choice of using the dollar in pricing oil doesn’t require a political agreement. Historically, there were no other currencies that had these three characteristics except the U.S. dollar, and this remains true to this day. Additionally, it is important to bear the following in mind: 

• Pricing oil in a single currency has the same problems associated with the U.S. dollar. 
• Pricing oil in a basket of currencies will not work, because OPEC members have different trading partners. While some members will benefit from the composition of the basket, others will lose. In addition, managing the basket is costly. 
• Pricing oil in the IMF SDR (Special Drawing Rights) doesn’t help for several reasons, including the fact that the U.S. dollar has the lion's share of it. However, the experience of the Suez Canal Authority with setting fees based on the SDRs is worth studying.

2. The Shanghai Stock Exchange settles oil contracts in China’s yuan, but data analysis shows that it is a mirror image of the dollar pricing of oil in the Dubai stock exchange, once it’s adjusted for quality, time and exchange rates. In other words, oil is priced in the U.S. dollar, but settlements are made in yuan.  

3. One must distinguish between pricing in the U.S. dollar and receiving revenues in other currencies. Some countries that have asked for oil revenues to be settled in non-dollar currencies did so because of U.S. sanctions. However, there is no evidence that oil-producing countries, which aren’t under U.S. sanctions, are voluntarily ditching the U.S. dollar in favor of other currencies.   

4. The Saudi riyal is pegged to the U.S. dollar, and the same goes for other currencies of Gulf States. (Kuwait uses a basket of currencies, but the dollar constitutes a large portion of it.) So why would Saudi Arabia and its Gulf allies ditch the U.S. dollar and hurt their own currencies? 

5. Saudi Arabia sells its oil under term contracts and does not use the futures market. Therefore, it does not need any exchange platform, let alone the Shanghai Exchange. The UAE, meanwhile, sells some of its oil in the spot and futures market, and it has its own stock exchange in Dubai. So, what’s the benefit of using the Shanghai Exchange when Saudi Arabia and the UAE have what they need? 

About the Authors

Dr. Anas Alhajji

Contributing Editor

Dr. Anas Alhajji is an independent energy economist and the former chief economist at NGP Energy Capital management. He is a well-known researcher, author, speaker and an award-wining academician and wood worker.