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Euros for oil: A first step, but towards what?

Marco Giuli

Date: 23/01/2019
Economic means are increasingly being mobilised to pursue foreign policy goals in international relations. Both the US and China regularly engage in economic statecraft and have taken an increasingly assertive posture to advance their priorities. The EU is called upon to deal with this trend and devise its own approach to defend its interests. The instrumentalisation of the role of the dollar in the context of US sanctions policy – which is interpreted as covering any transaction denominated in US dollars (USD) - is one dimension of this larger issue that has focused minds in Europe over the last year.

The current transatlantic tensions over Iran show how US economic statecraft – by way of extra-territorial sanctions – can damage European commercial and political interests. Following the US’ unilateral withdrawal from the Joint Comprehensive Plan of Action (JCPOA) and the issuance of new sanctions against Iran, large European companies such as Total, Airbus, Maersk, and Siemens have decided to leave the Iranian market, demonstrating the level of EU’s exposure to such actions.

Countering hostile economic statecraft: a role for the euro?

In reaction to this, German foreign affairs minister Heiko Maas called for the EU to shield Europe from the US’ sanctions against third countries, including by setting up a European Monetary Fund and an independent Swift system. Swift – a Belgium-based global payment management system – has been instrumental in enforcing US sanctions against Iran and Cuba. These calls were echoed by French finance minister Bruno Le Maire, who called for the creation of financing instruments outside the US’ control.

Against this background, the European Commission has issued a Communication calling for an enhanced international role for the euro and has adopted recommendations on the international role of the euro in the field of energy. Today, the oil trade is mostly denominated in dollars. In 2017, more than 80% of EU import of petroleum products was invoiced in US dollars, a percentage that ranged from 52% in Germany to almost 100% in Poland and the UK according to Eurostat. The Commission notes that if all EU countries switched to a euro-denominated invoicing, that would move about EUR 300 bn /y of international commercial transactions from the dollar to the euro, accounting for 16% of global fuels and mining trade.

According to the Communication, the expansion of the international use of the euro would help to protect European business’ exposure to legal actions taken by third countries’ jurisdictions, thereby advancing the objective of making the single currency a source of empowerment and protection. The Commission recommends to expand the role of the euro in international agreements related to energy, encourage a wider use of the euro by actors operating in the European market, and encourage financial actors to make larger use of the euro for energy-related projects and financial transactions.

The Commission’s initiative raises questions of feasibility, given the current international position of the euro, and concerning the willingness of EU member states to boost the role of the euro in the face of the dollar.

The EMU’s capabilities

In terms of feasibility, the euro would be well placed for a redenomination of energy contracts away from the US dollar. First, the EU is the largest net importer of fuel in the world. According to BP’s Review of World Energy, in 2017 the EU’s net oil import amounted to 11.74 M bbl/d, far ahead of the US (6.82 M bbl/d, on its way to self-sufficiency) and China (8.95 M bbl/d).

Second, its import structure is dominated by countries whose currency is not pegged to the US dollar. This is a relevant point since for dollar-pegged oil exporters – notably the Gulf countries – payments in a currency different from the dollar would raise a foreign exchange risk, providing them incentives to maintain the current denomination.

Third, the euro is already the world’s second largest reserve currency, accounting for 20% of central banks’ holdings of foreign currencies in 2018 according to the IMF. It is notable that, despite the fact that the Chinese RMB accounts for only 4% in foreign holdings, Beijing has already launched crude oil futures contracts priced in RMB.

The EMU’s limits

However, the implementation of the Commission’s proposal faces obstacles. First, it is unclear to what extent EU member states wish to boost the international role of the euro and reduce the US dollar status. Member states differ with regards to the dollar denomination of their respective external energy trade. Some of them, especially in Central and Eastern Europe (CEECs), are working to expand the import of US liquefied natural gas and seek oil and gas supply from the dollar-pegged Gulf countries to reduce the Russian share of their energy mix. These transactions are unlikely to be denominated in euro. CEECs’ exposure to US sanctions towards Iran (or Russia itself) is limited, while they privilege political and security bonds with the US over any timid declination of EU ‘strategic autonomy’.

Second, the effectiveness of a euro-denomination of energy deals to shield European firms from sanctions is limited. Beyond the legal and practical advantages that the US dollar gives to the US in tracking transactions and defining extensively the scope of the application of sanctions, Washington can resort to multiple forms of retaliation against foreign firms by, for example, banning companies from doing business in the US.

Third, linking the euro-denomination of transactions in strategic sectors to an enhanced international role for the euro risks triggering false expectations. The denomination of oil trade in dollars is more of a side benefit of the US dollar’s international stand rather than the source of it. Its status originates from the shift of the global balance of power after the two world wars, combined with the US’ ability to offer the world global public goods – including risk-free, liquid assets such as the Treasury bills. As such, the consolidation of the Economic and Monetary Union (EMU) as a more cohesive and strategic actor is a necessary requirement for elevating the role of the euro in international transactions.

The Commission seems to recognise this. The proposal to start with the voluntary use of the euro in energy deals shows awareness that there is little appetite in the EMU for the political steps required to raise the euro’s international status. These measures can, therefore, be understood as a signalling exercise concerning the unintended consequences that the use of the dollar as an enforcement tool for ‘America first’ policies may have. More broadly, proposing to strengthen the euro’s international role as a protection tool against a volatile geopolitical environment is a welcome step. Should the euro-denomination of strategic commercial transactions prove beneficial for European interests, member states could become more inclined to take bolder political steps to strengthen the common currency’s international stand.

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Credit photo: Cunégonde/LSD

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