Petrodollars: Definition, History, Uses

What Are Petrodollars?

Petrodollars are crude oil export revenues denominated in U.S. dollars. The term gained currency in the mid-1970s when soaring oil prices generated large trade and current account surpluses for oil exporting countries.

Then as now, oil sales and the resulting current account surpluses were denominated in dollars because the U.S. dollar was—and remains—by far the most widely used currency. The U.S. dollar's global popularity does not depend on the good will of oil exporters. It is based on U.S. status as the world's largest economy and goods importer, with deep, liquid capital markets backed by the rule of law as well as military power.

Understanding Petrodollars

Petrodollars are oil export revenues denominated in U.S. dollars. Petrodollars are not a distinct currency; they are simply U.S. dollars accepted as payment by an oil exporter.

Global crude oil exports averaged approximately 88.4 million barrels per day in 2020. That pace would generate annual global petrodollar supply of more than $3.2 trillion a year, assuming an average price of $100 per barrel.

Petrodollars are the primary source of revenue and wealth for many members of the Organization of Petroleum Exporting Countries (OPEC) as well as non-OPEC oil and gas exporters including Russia, Qatar, and Norway.

Just as the petrodollar is not a currency, neither is it a global trading system. The wide use of the U.S. dollar as payment for crude oil reflects the traditional preferences of non-U.S. oil suppliers.

Petrodollar Recycling

Oil exporters prefer the U.S. dollar because it is the pre-eminent global currency for global investments. That makes it the most convenient store of value for accumulated oil revenue, which needs to earn a rate of return to be useful.

An early example of petrodollar recycling is the 1974 deal between the U.S. and Saudi Arabia to funnel Saudi petrodollars into U.S. Treasuries.

Subsequent deals deployed Saudi oil export proceeds to pay for U.S. aid and development projects in Saudi Arabia and to finance U.S. weapons sales to the kingdom.

Many oil exporters now invest their petrodollars in stocks, bonds and other financial instruments through sovereign wealth funds. Norway's sovereign wealth fund had assets of about $1.4 trillion at the end of 2021. With a 72% allocation to stocks, the fund holds nearly 1.5% of the world's publicly listed shares.

The Problem With the Petroyuan

To evaluate the advantages for an oil exporter of getting paid in U.S. dollars, consider periodic claims over the past decade that the petrodollar would soon face a challenge from the petroyuan: oil exports denominated and paid for with Chinese currency.

All buyers of exported oil hold or can easily access U.S. dollars, while only China and mostly Chinese companies hold the Chinese national currency, called the yuan or renminbi. Unlike the U.S. dollar, the renminbi is not a freely convertible currency; its exchange rate against other currencies including the U.S. dollar continues to be managed by China's central bank.

U.S. dollars from crude exports can be easily invested worldwide, including in the $13.4 trillion eurodollar market for short-term dollar denominated deposits in European banks. Crude export proceeds in Chinese currency cannot be invested outside China as widely as USD, and can only be invested inside China at the discretion of the Chinese government. Though Chinese capital markets have grown fast, they remain much smaller and less liquid than U.S. capital markets.

To sum up, claims that the U.S. dollar's primacy rest on its status as the settlement currency for oil exports have it backwards: the dollar's status as the global reserve currency is what keeps it indispensable to oil exporters. The dollar was the established global store of value decades before non-U.S. crude oil exporters rose to prominence.

The Real Problem With Petrodollars

Petrodollars recycled into investments overseas or development programs at home can produce positive financial and social returns. Results are decidedly less positive when petrodollars are spent on fortifying domestic oppression, fueling an arms race or waging war abroad.

In recent years, actions including the murder of U.S. resident Jamal Khashoggi by Saudi state agents in Turkey and Russia's invasion of Ukraine have fueled concerns that petrodollars are financing war and human rights violations, while shielding perpetrators from accountability.

The Bottom Line

Petrodollars are U.S. dollars received in return for oil exports. The growth in global oil flows over time has increased the economic interdependence of crude exporters and importers and the volume of international capital flows. But the oil trade and related investments depend crucially on the U.S. dollar as the most widely accepted global currency. The U.S. dollar is unlikely to be supplanted as the global payments currency of choice in the near term.