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To: Haim R. Branisteanu who wrote (266234)	11/6/2003 7:40:32 PM
From: Haim R. Branisteanu	Read Replies (1) \| Respond to of 436258

Pricing Russian Oil in Euros: Implications for EUR/USD Published: 10/17/03 · While the immediate effect of an announcement would be a higher EUR/USD, fundamentally a re-pricing of Russian oil in euros should not affect the value of the dollar · The choice of currency in which to price oil matters only to the extent that it affects investor expectations of the dollar's global dominance Russia's recent consideration of pricing its oil in euros has received considerable attention in the news and attracted comments by European policymakers. The situation bears watching, as Russia's decision could have a significant long-term impact on the EUR/USD. The announcement to re-price is expected to spark a knee-jerk move up in EUR/USD-fundamentally however there are sound reasons why the currencies may not be impacted as much as some market-watchers may think. Conventional view: Russian oil re-pricing a prelude to a sharply higher EUR/USD Because the global oil trade is based in dollars, the US is the only country in the world that incurs no currency risk when it deals in the oil market. It is also the sole country that can print money to use for purchasing oil. As a result the US has a decided advantage as the world's reserve currency-dollar demand is driven in part by oil exporters and importers who are forced to hold large dollar reserves in order to participate in the oil market. In turn, these reserves help to finance US current account deficits by fueling demand for Treasury bonds. A move by Russia, the world's second largest oil exporter, to price its oil in euros poses a potential downside risk to the dollar as it opens the door for other oil exporters to follow suit. If oil were not priced in dollars, the argument goes, countries would have less of a need to hold dollar reserves and may rebalance their currency holdings. The effect of this rebalancing could lead to a sharp sell-off in the dollar as countries shift a portion of their dollar holdings into euros. Currency choice has no fundamental impact on USD Given Russia's trading relationship with Europe, a switch to pricing oil in euros may make sense as it effectively eliminates the exchange rate risk in the transactions. Fundamentally however, a switch to pricing oil in euros rather than dollars should have little to no net effect on the values of the currencies themselves. In a simplified scenario, consider a country like Russia, which purchases nearly half of its imports from Europe. If it uses its dollar-based oil revenues to buy imports, Russia must sell these dollars in the FX market to purchase the euros it needs to trade with Europe. The key point is that while Russia may need to hold dollars to trade oil, at some point it will also need to sell them to buy European imports. There may be a question of timing, i.e., when Russia decides to buy and sell dollars, but the net effect on the currency should be zero. Indeed, in terms of the relative values of EUR and USD, accepting oil payments in dollars and then converting them to euros is just the same as selling oil in euros to begin with. Any move by OPEC to re-price in euros would likely take years Arguably, EUR/USD could push sharply higher if other oil exporters, particularly OPEC, follow Russia's lead in switching to euros. This scenario however, underestimates the difficulty of transitioning to a euro-based oil pricing system on a large scale. Currently the entire oil market, including complex trading and hedging mechanisms, is based around the US dollar. Consequently, re-organizing around the euro would itself entail risk, as it would be an extraordinarily time-consuming and costly process. In addition, OPEC oil prices are derived from formulas using other marker crude oils (e.g., WTI, Brent), all of which are priced in dollars. Until these markers change denomination, OPEC will be forced to continue pricing oil in dollars. Finally, there are countries other than the US that view the current system as beneficial. A switch to pricing oil in euros would not be in the interests of countries that have significant trade flows in USD, or those that hold large stores of US assets. In sum, the displacement of the dollar as the denomination of choice in the oil market will likely take a significant amount of time. Choice of currency for oil may not matter for EUR/USD, but expectations do The re-pricing story is important to the extent that it affects world opinion on US dollar dominance. While the re-pricing of oil in and of itself may not affect the value of the dollar, it may change global perceptions about the status of the dollar as the world's single reserve currency (currently the dollar comprises approximately two-thirds of global currency reserves). These shifting perceptions, rather than the currency that oil is traded in, could have a very real effect on the dollar's value. If expectations were to change, the dollar could come under pressure as countries, particularly oil exporters, raise the proportion of their euro reserves (much like Russia did earlier this year). Given the roughly $300 billion that OPEC countries earn annually in oil revenues, any shift they make out of dollars could significantly impact EUR/USD.