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Sunday, November 18, 2007 6:10 PM

Oil Pricing Unit Red Herring

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All of this talk about what oil is priced in is a needless red herring. In an on again off again situation Saudi Arabia Won't Include U.S. Dollar in OPEC Talks.

Saudi Arabia, the world's largest crude oil exporter, rejected a proposal by Iran and Venezuela to discuss the weak dollar at this weekend's OPEC summit in Riyadh, saying it didn't want the U.S. currency to "collapse."

Saudi Arabia won't discuss pricing oil in currencies other than the dollar, Saudi Foreign Minister Prince Saud Al-Faisal said, speaking at a meeting of oil and finance ministers today that was accidentally broadcast to journalists.

The Organization of Petroleum Exporting Countries, which pumps more than 40 percent of the world's oil, has seen its revenue diminish because of the decline in the dollar over the past three years.
My Comment: This is of course total nonsense. Revenues have not diminished one iota over three years because of the decline of the dollar. However, the value of currency reserves has diminished in that time frame. These are separate and distinct items and it is extremely important to not confuse the two.
Some OPEC members have said they will consider increasing transactions in euros. The dollar has fallen almost 15 percent against the euro in the past 12 months.
My Comment: The key word in that sentence is "increase". There is the smoking gun I have been waiting for a long time. Oil transactions are already taking place in Euros. That is proof that oil does not have to be priced in Euros to trade in Euros. This of course is perfectly logical since gold is priced in dollars but trades in every major currency, but for some reason oil conspiracy advocates have been demanding proof. There it is.
"If oil was traded in something else than the dollar it would accelerate the long-term diversification trend out of the currency," said Meg Browne, a senior currency strategist at Brown Brothers Harriman & Co. in New York. "But the chances of that happening is small -- it's simply not convenient for these countries when so much of their economies is priced in dollar."
My Comment: Meg Browne is yet another person who is putting the cart before the horse. Furthermore, as we have seen, oil is already trading in something other than dollars. Thus she is wrong on two counts.


Sentiment against the dollar is so extreme now, that you can count me in the group that expects the US Dollar index to rally. The reason is the dollar index is heavily skewed to the Euro (57.6%) and I expect the love affair with the EURO will soon reach a peak. There is no real justification for the Euro to be trading where it is except for sentiment. But sentiment is a very powerful driving force behind currency fluctuations, and in fact behind all trading.

I have no long standing love affair with the dollar per se, and in trade weighted terms I expect it to sink. In other words I expect the dollar to fall vs. Asian currencies, especially the Yen.

Yen Daily Chart

click on chart for a crisper image

The Yen is breaking out of a lengthy consolidation to the upside and I expect that trend to continue. The ramifications of this are huge but more on this at a later time. For now let's return to the pricing unit.

Oil Sentiment vs. Pricing Unit: Which is the Cart and Which is the Horse?

Dollar bears were all over the OPEC Pricing Unit story as if this somehow would cause Dollar Armageddon. There are still those who believe we attacked Iraq over pricing units and that we will attack Iran over its oil bourse. Such stories are sensational as well as misguided hype.

Pricing oil in something other than dollars absolutely 100% guaranteed will not cause the dollar to collapse. Nor would it accelerate long-term diversification out of dollars.

Ten Simple Facts

1) Oil is priced in dollars.
2) Oil trades in Dollars and Euros right now in spite of the pricing unit being dollars. OPEC has recently admitted this fact.
3) Clearly oil does not have to be priced in Euros to trade in Euros, or for that matter priced in Yen to trade in Yen. The same applies to any major currency.
4) Neither Venezuela or Iran hold any dollar reserves. To the extent that either is taking trades in dollars, there is clearly nothing forcing them to hold dollars. By extension there is nothing forcing any OPEC country to hold dollars if it doesn't want to.
5) It takes less than a second for Forex trades to take place. 24 hours a day, 7 days a week, one can sell any currency they want and buy any other currency.
6) The above logic applies to any currency and any commodity.
7) Nothing is stopping anyone at any time anywhere from selling dollars for whatever currency they want to hold. Nor is anything stopping anyone anywhere at any time from selling any major currency for U.S. Dollars.
8) Because currency conversion is instantaneous no one has to hold U.S. dollars to buy oil, copper, gold, iron, lead, wheat, soybeans, or anything else.
9) Dollars are held (or not held) for reasons totally unrelated to pricing unit. Some of those reasons are political, some are based on sentiment, some on trade patterns and trade relationships, and some to suppress the value of local currencies to improve exports.
10) Currencies float and so do the price of oil and commodities. Pricing oil (or any other commodity) in Euros will not cause a price change in dollars. Look at gold which is simultaneously priced in everything as proof.

The above 10 points are simple facts.

Conclusion: Not only is oil priced in dollars a red herring discussion, the entire commodity pricing in dollars discussion is a red herring discussion.

It's amazing that this is so obvious when it comes to gold, but so hard to understand when it comes to oil.

What does matter is where countries hold their reserves. With that in mind, let's return to a falsehood from the article: "OPEC, which pumps more than 40 percent of the world's oil, has seen its revenue diminish because of the decline in the dollar over the past three years."

The above idea is clearly false. Currencies float and so does the price of oil. Pricing oil in Euros will not cause a price change in dollars. What is true however, is the value of dollar reserves held by any country or individual has decreased over time. That is a different matter, and is independent of the pricing unit. Furthermore, and as discussed earlier nothing is forcing any country to hold dollars if it does not want to hold dollars. Pricing oil in Euros would not alter that simple fact.

So, what's behind the rise in the Euro?

The likely answer is diversification by oil producing states as well as China out of dollars into Euros. In other words anti-dollar sentiment is the driving force. Weakness in the dollar stems from lack of desire to hold dollars. The lack of desire to hold dollars is spurring red herring talk on pricing units, mostly for political purposes and mostly by Iran and Venezuela.

Let's put the horse in front of the cart where it belongs.

Pricing oil in Euros will not cause anything to happen. If pricing unit changes do happen, they will be a result of sentiment changes in regards to existing dollar hegemony and not the other way around. What's likely to happen is multiple simultaneous quotes for oil will be presented just as we see multiple simultaneous quotes for gold today. This will not cause anything to happen, it will merely reflect various currency relationships. It certainly will not be dollar Armageddon.

Mike Shedlock / Mish
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