• The petrodollar system, formalised in the mid-1970s, ensures that oil transactions worldwide are denominated and settled in US dollars, creating structural global demand for the US currency that has underpinned dollar dominance in global reserves for five decades.
  • Five of six GCC nations have hard-pegged their currencies to the US dollar, creating a direct transmission channel between Federal Reserve interest rate decisions and Gulf government budgets, borrowing costs, and fiscal stability.
  • De-dollarisation efforts are gaining pace, but the US dollar still accounts for roughly 80% of global oil transactions⁽¹⁾ and the structural barriers to rapid displacement remain significant.

Oil markets run on US dollars. Not because of a formal international treaty, but because of an economic arrangement that crystallised in the 1970s and proved so structurally convenient that it has endured for half a century.

The petrodollar system is the reason every barrel of crude traded internationally is priced and settled in US dollars. For GCC economies that earn, budget, and borrow in those same dollars, the implications run far deeper than a pricing convention.

How the Petrodollar System Works

The arrangement traces to the 1973 oil embargo and its aftermath. The US economy had abandoned the gold standard in 1971, and Washington needed a new structural anchor for global dollar demand. In late 1974, the US and Saudi Arabia reached a bilateral understanding⁽²⁾.

The details of this arrangement remained classified until Bloomberg obtained them via a Freedom of Information request in 2016. Under the agreement, Saudi Arabia would price its oil exports in dollars and reinvest surplus revenues into US Treasury bonds in exchange for military support.

By 1975, all OPEC members had adopted dollar-only pricing⁽²⁾. Every oil-importing nation on earth was now required to hold US dollars to purchase energy, embedding structural global demand for the currency.

The effect on dollar reserve status was immediate and lasting. At end-2024, the US dollar comprised 57.8% of global official foreign exchange reserves⁽³⁾, per IMF COFER data, down from a peak of 72% in 2001 but still far ahead of any rival currency.

What This Means for GCC Economies

Five of the six GCC countries have hard-pegged their currencies to the US dollar: Saudi Arabia, the UAE, Qatar, Bahrain, and Oman. The Saudi riyal has been fixed at 3.75 per dollar since 1986 ⁽⁴⁾.

Kuwait’s dinar is tied to a currency basket but retains significant dollar weighting. This peg creates a direct channel between the Federal Reserve and Gulf fiscal health. When the Fed raises interest rates, Gulf central banks typically follow in order to defend their pegs, which raises domestic borrowing costs in tandem.

Dollar strength also affects the real purchasing power of oil revenues: a stronger dollar allows GCC governments to purchase more globally priced goods and services with the same barrel of income, but it raises the cost of USD-denominated debt service and tightens import budgets.

When the Fed eases, dollar-denominated revenues lose relative purchasing power, narrowing the fiscal cushion.

GCC sovereign wealth funds, which hold large positions in US Treasuries, also see the value of those holdings move with Fed policy, adding a second layer of transmission from US monetary decisions to Gulf balance sheets.

When the Petrodollar System Faces Pressure

The geopolitical turbulence of 2025 and 2026, including escalating Strait of Hormuz tensions, has sharpened debate about the system’s durability.

China launched yuan-denominated crude oil futures in 2018 and has expanded renminbi settlement, particularly with sanctioned exporters including Russia and Iran. As of 2024, only 3.7% of global cross-border trade was settled in yuan⁽⁵⁾, according to S&P Global, and the dollar still accounts for approximately 80% of global oil transactions ⁽¹⁾.

The structural barriers to replacement are substantial: the depth of US Treasury markets, the network effects of five decades of dollar-priced contracts, and the absence of a fully open Chinese capital account all constrain adoption of an alternative, regardless of political intent.

A Strong Dollar Can Also Suppress Oil Demand

The petrodollar arrangement creates a feedback loop that can work against producers. Because oil is priced in dollars, a sharp appreciation of the currency makes the same barrel more expensive for buyers operating in euros, yen, rupees, or other non-dollar currencies.

The ECB has documented this inverse relationship⁽⁶⁾: dollar strength tends to reduce oil consumption in import-dependent economies by raising its effective local-currency cost. For GCC producers, this creates a structural bind.

A stronger dollar increases the nominal purchasing power of their revenues while simultaneously eroding the volume of global demand for the commodity that generates those revenues.

Conclusion

The petrodollar system is not an arrangement that can be unwound overnight. It is a structural feature of global finance, embedded in the reserve practices of central banks, the settlement conventions of commodity markets, and the currency architecture of GCC sovereign economies.

Understanding how the dollar-oil link transmits Federal Reserve decisions into Gulf balance sheets is foundational to interpreting geopolitical risk in energy markets.

Sources: ⁽¹⁾ J.P. Morgan, ⁽²⁾ Bloomberg, ⁽³⁾ International Monetary Fund, ⁽⁴⁾ Saudi Central Bank (SAMA), ⁽⁵⁾ S&P Global, ⁽⁶⁾ European Central Bank