The petrodollar: how oil and the US dollar got married

Every day, millions of barrels of oil are bought and sold around the world. Almost all of those transactions are priced in US dollars, regardless of where the oil comes from or where it is going. A Japanese refinery buying crude from Saudi Arabia pays in dollars. A Chinese power company buying from Angola pays in dollars. This convention, which emerged from a set of agreements in the early 1970s, has consequences that extend far beyond the oil market itself. It is one of the reasons the US dollar retains its position as the world's dominant reserve currency.

How the petrodollar system came about

After the United States ended the convertibility of the dollar to gold in 1971, the currency needed another anchor to maintain its global role. A series of arrangements with major oil-producing nations, particularly Saudi Arabia and other members of what would become OPEC, established that oil would be priced and traded in US dollars. In return, the United States provided security guarantees and access to arms. The arrangement meant that any country needing to buy oil, which is essentially every economy in the world, first needed to acquire US dollars, creating a permanent global demand for the currency.

Why this matters beyond oil

The requirement to hold dollars to buy oil has several structural effects. It keeps demand for US dollar assets consistently high, which allows the United States to borrow at lower interest rates than it otherwise could. Countries that run large oil export surpluses, particularly Gulf states, have traditionally recycled much of that revenue back into US dollar assets, particularly US Treasury bonds. This recycling, sometimes called petrodollar recycling, has been a significant source of demand for US government debt.

The arrangement also gives the United States significant leverage. Because so much global trade is settled in dollars and flows through dollar-denominated financial systems, the United States can use access to those systems as a geopolitical tool, most notably through financial sanctions that cut off targeted countries or individuals from dollar-clearing networks.

Challenges to the system

The petrodollar system is not legally mandated; it is a convention reinforced by network effects and the depth of dollar markets. In recent years, some oil-producing and oil-consuming nations have explored settling energy trade in other currencies, including the Chinese yuan. These moves have been modest in scale so far, partly because no other currency offers the same liquidity, legal infrastructure, and global acceptance as the dollar. But the direction of discussion reflects a broader trend toward questioning dollar dominance, sometimes called dedollarisation.

What it means for Australia

Australia imports a significant proportion of its liquid fuel, and that fuel is priced in US dollars. When the Australian dollar weakens against the US dollar, import fuel costs rise in Australian dollar terms, flowing through into petrol prices at the bowser and freight costs across the economy. The petrodollar system also affects Australia's terms of trade indirectly: commodity exports priced in US dollars, including iron ore and coal, become more or less competitive depending on the strength of the dollar. Understanding the petrodollar helps explain why a decision made by a Saudi minister or a US Federal Reserve official can appear at an Australian petrol station within weeks.

The bottom line

The convention of pricing oil in US dollars was a political as much as an economic arrangement, and it has given the United States structural advantages in global finance for decades. Any shift away from it would have consequences that reach well beyond the energy market, including for Australian fuel costs and export earnings.

This article was compiled by AI and screened before publishing. See our editorial standards.