THE PETRODOLLAR

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This is one of the research Papers submitted for my Global Energy Course. Though a bit judgmental, these represent solely my views and no one else.

Who controls the food supply controls the people; who controls the energy can control whole continents; that controls money can control the world.

— Henry A. Kissinger

The price of crude oil over the last 10 years has risen by over 350% in USD, over 250% in Euros but the price of oil vis-à-vis the price of gold has remained constant. This points us to a very interesting reasoning of inflation of the USD and the subsequent diminishing value of USD. Experts believe that the only way to curb the sky rocketing prices of crude oil, is to curb the reckless printing of USD bills.

On August 15th 1971, President Nixon took the US dollar off the gold standard. The inside sources say that OPEC did consider moving away from dollar oil pricing, as dollars no longer had the guaranteed value they once did. The US lobbied with Saudi Arabia in the 1970s to ensure that the world’s most important oil exporter stuck with the dollar. Considering the monopoly of oil production in the Middle East, the OPEC followed anything that received consent from Saudis. International oil trades at New York’s NYMEX and London’s IPE were (and still are) strictly denominated in dollars, hence the name ‘petrodollar’. Most of oil traded in the world is through the USD.

The goods and services imported by United States are paid in USD to the producing nation. As a part of the cycle, the producing nations pay their oil bills in dollars to the Middle East producers. These dollars received by the oil producers flow back into the Federal Reserve in New York. This concept is commonly known in international political circles as Petrodollar recycling or Petrodollar cycle. And in response to this cycle, all United States needs to do is print the bills. Essentially this has two effects on the economy of United States of America, it keeps the value of USD artificially inflated with respect to other currencies and given USA precarious flow of credit. The Petrodollar cycle has contributed significantly to the $15 Trillion debt.

The US military and the USD are the two pillars that have helped United States establish hegemony over the years. Any shift in the scales with the valuation of USD would definitely harm the military and vice versa. A sound understanding of the petrodollar concept is essential to comprehend the current political turn of events in the Middle East.

The military might of United States protecting the other pillar, the US Dollar, was at display during the war with Iraq in 2003. Saddam Hussein, after decade-long economic sanctions, was ready to export oil to the Euro nations and the world. In November 2000, Saddam Hussein decided to trade the oil in Euro denominated currency. The reason for this was a mix of economic and political elements. He decided to forgo dealing with the “currency of the enemy” also for the reason that the Euro seemed to be 17% more valuable vis-à-vis the dollar. Almost all of Iraq’s oil exports under the United Nations oil-for-food program were paid in Euros since 2001. Around 26 billion Euros (£17.4bn) was paid for 3.3 billion barrels.

The trading of oil in Euros was considered blasphemous and was one of the reasons for the attack by US army on the pretext of weapons of mass destruction, which the military was unable to find eventually. Once the Saddam was put to death, USA ensured that the trading of oil in Iraq happens through dollar denominated currency. The global economists have always held Petrodollar as one of the top reasons for the invasion of Iraq in 2003.

Iraq is often claimed by experts to have shot at its own foot, and its neighbor, Iran, was in similar waters. Though Iran and Iraq share a very bitter history, they have irked United States and its stock currency, the dollar, in a very similar style. In 2005, Mohammad Javed Asemipour stressed the vision of initiating the trade of petrochemicals and light sulfur crude (and eventually regular crude) in its own oil exchange on Kish Island in the Persian Gulf, southern Iran. Iran proclaimed that the trade could be carried on in the Euro denominated currency. As the Kish Bourse gains momentum, Iran has offered to trade in a basket of currencies that is preferred to the seller and the buyer. This could pose some serious threat to the hegemony of US dollar as the paramount currency. United States and the European Union have unanimously imposed sanctions that have made international financial transactions for the government and Iran’s business community more costly. Iran has increased its offense on the United States to continue trading in either dollar or trading with the home currencies such as Rupee and Yuan. Coincidentally, on March 20th 2007, Levey told the Senate Committee on Banking, Housing and Urban Affairs that unilateral US financial sanctions “warn people and businesses not to deal with the designated target.“ The sanctions are now targeting foreign banks that handle transactions for Iran’s national oil and tanker companies, and companies or individuals involved in dealing with Iran. The sanctions are perceived in international political circles, as an attempt to cripple Iran trade and thus cash strap it. Iran, though, cannot be considered morally supreme with its impending nuclear program, and the Petrodollar is one of the many reasons why United States cannot ignore Iran or its imminent threat to the US.

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Why its time for the Gasoline Engine to Bid Adieu

It almost seems as though public transportation and electric vehicles in the United States faced similar battles at different points in time; the petroleum companies cartel pushed for development of the famed US highway system which encouraged consumers to buy more cars and spend more on gasoline while the electric vehicles are facing stiff resistance from policy makers and benefactors of the petroleum regime to institute a new model of operation which is economically viable.

Most electric vehicles today can run on a single charge for about 130 miles. Beyond that, the car needs to be charged for about 6-8 hours to return to full charge. One will argue that 130 miles is hardly sufficient for hassle free transportation which results in the often used term ‘range anxiety.’ This purely refers to the limited range an electric vehicle can travel on a single charge. But wouldn’t this problem be mitigated if we develop charging stations every 100 miles? The gasoline station infrastructure came into being in the US in the early 1900s and has had an extensive network across the country for over 40-50 years. Will the automobile sector have taken off, had there been no fuelling stations? Certainly not, and therein lies our answer to the mass adoption of electric vehicles. The infrastructure needs to come first and then the customers will follow, PERIOD.

I was listening to a talk by Shai Agassi, founder of Better Place, a venture capital backed American-Israeli company based in Palo Alto which develops transportation infrastructure for electric vehicles. According to Shai, the solution to mass adoption of electric vehicles lies in dissociating the ownership of the battery from the entire system. His recommendation is to have ‘swap stations’ where car drivers go up to gasoline stations and replace their discharged battery with a new, fully charged battery for a fee. Since the battery constitutes about 30-40% of the cost of the system, the cost of ownership of an electric vehicle is reduced substantially but the battery cost will have to be amortized over the lifetime of usage. Here’s where the problem arises when you give the customer such a heavy “discount” at purchase. Your refueling/re-charging expense will be then comparable or even higher than gasoline resulting in value degradation in the minds of the customer.  In my opinion, battery ownership with a nominal fee on every swap is smoother business model.

Shai also discussed the extremely progressive measures adopted by Isreal for promoting electrics. Apparently, there is a 70% tax on usage of gasoline-powered vehicles compared to just 10% for non-gasoline. This will go a long way in driving adoption of electric vehicles. What’s more, its not just not like any other subsidy where tax dollars are used to drive consumption; in this case, the tax slab for electric vehicles will be increased constantly as demand increases but the delta of 60% between gasoline and non-gasoline vehicles would remain constant. The policy is a win-win-win; for EV companies,  the government and consumers. Once EVs become mainstream, the taxes will be much higher and in a sense the EVs will be promoted as mainstream while the internal combustion engines (ICEs) will be ‘taxed out’. In other words, the policy states that if we buy an electric vehicle today at a lower tax rate, we can sell it four years hence at a price higher than acquisition cost due to the increased taxation in the future- a clear profit motive for early market entrants.

Coulomb technologies, another bay area start-up with its proprietary charging station infrastructure forms another part of this EV puzzle.  About a year ago, I had the opportunity to meet with Richard Lowenthal, founder and CTO of Coulomb. It was fascinating how Coulomb was going about seeding the market, talking to legislators, policy makers and consumer bodies and educating them on how an efficient charging station infrastructure can help reduce our dependence on the grid. Coloumb has created what is called the ChargePoint Network for recharging electric vehicles which are being deployed in cities, availability of which can be checked online. Moreover, a ChargePoint station for use at home is available for about $2500 which will allow for customers to charge vehicles at the most optimum pricing using demand side management and call centre support for charging issues. This idea can be revolutionary when used by swap station owners as they will be considerably reducing costs of charging batteries, thereby increasing their profit margins.

The third piece to this story is the battery itself and that’s why its important for us to understand how Tesla Motors is pushing the limits of the Lithium Ion technology in having batteries run for over 300 miles on a single charge. That is more than twice that of batteries in most other electric vehicles such as the Nissan Leaf and the Chevy Volt. I believe that Tesla’s cars with its over $100,000 price range will attract only those customers who are rather price insensitive. They buy electric vehicles because its cool and because Tesla plays to the gallery of having a sports vehicle packaged as an EV. But if battery technology can be pushed to giving us over 300 miles on a single charge, we would have no apparent reason to complain. A charging station and swapping infrastructure dotting national highways or interstates is a clear and very feasible solution.

I did a very basic cost benefit analysis by comparing the Nissan Leaf with Toyota Corolla, Honda Accord and the Nissan Versa Hatchback.

Toyota Corolla

Honda Accord

Nissan Versa Hatchback

Nissan Leaf after Tax Savings

Car Purchase Price

 $17,000

 $22,000

 $15,000

 $28,000

Miles/gallon

 $27.00

 $23.00

 $28.00

$/Gallon

 $3.60

 $3.60

 $3.60

$2.4 for full charge

Lifetime of Usage

 $100,000

 $100,000

 $100,000

 $100,000

Total Gallons In Lifetime

 $3,704

 $4,348

 $3,571

Total Op. Ex

 $13,333

 $15,652

 $12,857

 $1,846

Total Cost

 $30,333

 $37,652

 $27,857

 $29,846

It’s clear that if you compare any vehicle in the price range above $17,000, the Leaf will win, hands down. But if you were to compare apples to apples and pit the Versa Hatchback against the Leaf and discount all other benefits associated with EVs, you might end up paying a few thousand dollars more for the leaf. But hang on, what about the costs associated with maintenance of an ICE beyond 100,00 miles? And wait a minute- did we compute the increased resale value of the Leaf since the battery is designed for 200,000 miles of operation? Again, didn’t we say that the batteries could be swapped and that what you have at any given time is a fully charged battery supplied by the recharging station? So what we have to incur is only the annual maintenance charge or the extended warranty charge which will be the case even in gasoline powered vehicles.

Overall, I believe that it is an almost no-brainer decision to switch to electric. The consumers need to have a profit motive albeit not through a myopic lens, legislators must take bold moves to drive adoption and car companies must incessantly innovate and not worry about EVs cannibalizing their ICE business- a reality which is not that far away from now!