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Saudis turning toward Moscow and Beijing as US petrodollar power declines

The global financial status quo in place since the end of Bretton Woods in 1971 is facing its demise

House Intelligence Committee member Rep. Joaquin Castro, D-Texas, center, flanked by Rep. Denny Heck, D-Wash., left, and Rep. Rick Crawford, R-Ark., questions FBI Director James Comey on Capitol Hill in Washington, Monday, March 20, 2017, during the committee's hearing on allegations of Russian interference in the 2016 U.S. presidential election. (AP Photo/J. Scott Applewhite)

Neither a wise man nor a brave man lies down on the tracks of history to wait for the train of the future to run over him. – Dwight D. Eisenhower

Once upon a time just about anything relating to the oil business and Saudi Arabia was also seen as being in lockstep with, or at least in broad agreement with American interests. America was to provide the military backstop to ensure regime stability, and provide for a secure route to meet America’s oil import requirements.

The Gulf producers enjoyed supplying the onetime largest consumer of their oil, while oil traders bought, sold, and shipped exclusively in US Dollars to the world. Almost everyone smiled all the way to the bank, some of the time. Today it looks as though that cozy train is definitely leaving the station and new passengers are rushing to board.

The key asset of the Kingdom of Saudi Arabia is of course oil, and oil in Saudi Arabia is ARAMCO. The origins of the Arabian American Oil Company (ARAMCO) go back to the May 1933 when the majority shareholder was Standard Oil of California (SOCAL, now Chevron). Since the 1980’s when American shareholders exchanged their rights, it became a wholly owned Saudi company officially named Saudi Arabian Oil Co., but still called ARAMCO.

Today there is strong interest by Russian banks and a joint Russia-China investment fund to be a part of ARAMCO’s initial public offering (IPO). A number of other banks and investment groups in Russia and China are also eager to invest in ARAMCO shares. Russia and Saudi Arabia, the world’s two largest oil-producing nations, have embarked on the path to support their mutual and individual sovereign interests and have given up their sometimes-fiery competition.

One of the reasons is an effort to keep crude prices at a sustainable level in the face of increasing production and exports by U.S. shale drillers. This has been seriously developing in the US over the past 15-20 years.

It is important to look at history to appreciate the tectonic shift in economic and geopolitical relations the synergy between Saudi Arabia, Russia and China present to the world as we move forward in time. Today Russia is the largest energy producer, Saudi is second and China is now the biggest buyer. Therefore, a short stroll through history might help and refresh what we are seeing unfold.

In the summer of 1944, representatives from 44 nations met at Bretton Woods USA and agreed to “peg” their currencies to the U.S. dollar. Towards the end of World War II, it was the only currency strong enough to meet the growing demands for international currency transactions.

What made the dollar so attractive then for international use was each US dollar was based on 1/35th of an ounce of gold, and that physical gold was sitting inside the US Treasury. The value of gold was at that time firmly fixed by law at US$35 per ounce, making the expressed value of the greenback quite stable.

Since neither World War actually touched American shores, the US economy at that time was incredibly strong and demand driven, selling its goods throughout a needful world. The US government was committed to convert dollars (if needed) to gold on demand at any time at the fixed rate, the US dollar also earned interest and was more usefully mobile than gold.

Everything was looking fine for the US Dollar through the 1950’s until the 1960’s came around with a double whammy. One was the Kennedy/Johnson administration era vision for the “Great Society” and its new socialized programs like Medicaid, Food Stamps, Job Corps, Funded education, Job training, direct food assistance, direct medical assistance and others. At the time when these entitlement programs started more than 4 million people immediately signed up for these social and economic benefits. These new social programs demanded dollar resources that only expanding the national debt could provide, at the same time taxation was already considered excessive so it was off the table.

The other shoe that dropped at the same time was the Vietnam War; it was costing the US $500 Billion. The US simply could not print enough money to cover its war costs, the nation’s gold reserve had only $30 billion, and that reserve was already in use backing existing US dollars. To Increase taxes, the usual tried and true response, was politically unacceptable at that time.

As a result, in 1971 President Nixon in one sudden bold stroke annulled the Bretton Woods agreement. This sent shockwaves throughout the world as he did this without consulting the other signatories of Bretton Woods; surprisingly even the US State Department was not consulted. This resulted in a total break of any linkage between the US dollar and gold. The US dollar overnight became a fully floated fiat currency, the US government now had no constraints aside from sanity, and common sense to print all the money it felt was needed (the 1971 version of today’s QE’s).

The result was an unprecedented printing of US dollars to paper over both war and expanding entitlements costs. This in turn raised the very real concern by the administration of how to maintain the strength of the US Dollar in the face of this energetic printing and spending binge.

Nixon and his closest advisors saw a wonderful opportunity in Saudi Arabia who was a major supplier of America’s oil imports. Nixon and the Saudi’s came to an agreement, and literally overnight Saudi oil could only be bought with US dollars. This caused an immediate global reaction and outcry, but it was a ‘done deal’, resulting in a huge demand spike for US dollars as well as the first oil crisis. By the time 1975 rolled around all the other OPEC members got on board the US/Saudi wagon, and committed to selling their oil exclusively in US dollars as well.

The market for recycling of these “petrodollars” was tremendous, with buyers of bonds and notes clamoring for these government issued papers. It was largely seen at the time as the best, most secure game in the world backed with an “endless flow of Black Gold”, and it has remained mostly unchallenged for 40+ years until recently.

Perceptions about the dollar today are changing and being critically reassessed. The activities of the US Federal Reserve and the central banks of the EU and Japan are under scrutiny and testing the boundaries of trust as never before. The need, acutely felt among many nations, is for reliable diversification away from the dollar as being in their sovereign national interests and not to feed the seemingly ever-ballooning debt and account deficits of the US.

For curiosity’s sake (and as I happen to have these numbers handy), consider that at the end of fiscal year 1971 the US national debt was $398 Billion, and the debt/GDP ratio was at 34%. At the end of fiscal year 2017, the US national debt was $20.245 Trillion, and debt/GDP ratio was at 104%. Looking back, it would seem that Nixon had no problems when compared with the numbers being tossed around today, but we no longer have a plan B to create a “petrodollar 2”, or rates high enough to force lower for wiggle room.

Coincidentally, and perhaps it was a quid pro quo agreement between the US and Saudi governments, the exclusive debut of the petrodollar saw at the same time the total rearrangement of ARAMCO. Prior to 1973, the US shareholders in ARAMCO recognized something was afoot, but may have still held out hope to retain some of their equity in ARAMCO’s operations. This did not happen. In 1974, Saudi Arabia took over 60 percent of ARAMCO ownership. By the end of 1975, the Saudi government told the remaining US shareholders that it wanted 100 percent of the company. By 1980, the Saudi government owned 100 percent and all company assets.

Meanwhile, and to this day the petrodollar has ruled the oil markets, and US companies like Schlumberger, Halliburton and a host of Texas and Oklahoma oil service companies ensured that wells worldwide kept pumping for dollars, but that too is changing, faster than many analysts appreciate. It is worth considering that over the past 40+ years several generations of local professionals have been educated and have worked very well at the highest technical levels in the industry.

While the above has been developing, China has not been sitting idly twiddling its thumbs. The Chinese, today the largest single buyer of Russian, Saudi and Gulf oil and now employ means other than the petrodollar to buy their energy. The yuan is now used, the ruble is now used, and gold is now used. Next month the yuan/gold oil contract will start actively trading out of Shanghai. The de-dollarized multipolar energy train is inexorably gathering speed.

Ten years ago, it would have stretched credulity that Russia and Saudi Arabia would or could cooperate economically or politically, yet here we are. Same with the Russia – China relationship, yet here we also are. ARAMCO is today considering investing in Russia’s Arctic LNG capacities, an opportunity which became glaringly obvious because of US-led Western sanctions against Russia.

The two energy giants have seen the successful results achieved by working together, managing the oil markets volatile moments, oil-cuts agreements, and are willing to press forward by reaching new energy agreements, including liquefied natural gas. The synergy is there with Russian companies now looking to build regasification terminals in Saudi Arabia because the kingdom will need them especially if they decide to import LNG, which is today under consideration.

The relationship has also gone beyond oil or gas. A Saudi decision is due in 2019 on an official proposal to build two Russian nuclear reactors in the kingdom. Where and how quickly these new relationships and realignments will take us is still unclear, and there is opposition, mainly from the US and EU who are not comfortable with these developments which largely exclude them, but the train is already leaving the comfort zone.

Paul Goncharoff is an American business executive working in Russia.

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