At the third OPEC heads of State summit recently, some members expressed concern over the weakening of the dollar, and members such as Iran and Venezuela signalled the desire to shift to a different pricing system based on a basket of currencies. Saudi Arabia, among others, is opposed to the idea. Commenting on the development, Barclays Capital said the move was highly unlikely because it would necessitate a major overhaul of the existing pricing system, given that OPEC crudes are currently priced in terms of dollar adjustments from dollar-denominated benchmarks.

Mahmoud Ahmadinejad, president of Iran, reckons he has pinpointed the soft underbelly of the US: the dollar. He urges OPEC to consider pricing crude oil in other currencies. Iran can invoice its oil customers in cowrie shells if it likes, but that would not change the underlying value of the product. Shifting oil markers to other currencies would only make for inefficient markets.

It could potentially hit the dollar, although only through secondary effects: by knocking confidence and spurring diversification of global foreign exchange holdings.

The key player in OPEC is Saudi Arabia. The dollar’s slide, exacerbated by the riyal’s peg to the currency, has increased Saudi inflation, but this is still some way below rates in other Gulf economies. Saudi Arabia has faced periods of dollar weakness several times before. It would have to weigh the temptation of a wholesale riyal revaluation or dumping of dollar assets against the risk of destabilising the economy of the US, which is simultaneously the world’s largest oil consumer and ultimate guarantor of Saudi’s security.

Iran’s political motivation for undermining the dollar is clear. That both Iran and its petro-ally Venezuela are struggling to meet even their own Opec production quotas also explains their hawkish stance on output.

Saudi Arabia has agreed to a vague commitment by OPEC to "study" Iran’s proposals. This suggests it is trying to accommodate the group’s divergent economic and political aims. Riyadh also boosted funding for greener, but still oil-based, energy initiatives, betraying an awareness that high prices are spurring energy diversification efforts elsewhere. Rather than fiddling with the dollar, Saudi Arabia’s small concession on wording may be designed to secure consensus on more pressing issues - namely, OPEC’s need to increase output and boost long-term investment in new fields to slow the search for alternatives to oil.

How really dollar behaves with oil ?

Is there a negative correlation between the US dollar and crude prices? Many think the two must move in opposite direction. While, it is a fact that the two are currently at variance in the direction of movement (dollar weakening and crude rising), it has not always been the case. There is also an impression that changes in the currency and the commodity markets feed on each other.

If anything, the negative relationship between the greenback and crude is far more tenuous than many might think, according to experts at Barclays Capital, who point out that there is no evidence that periods of dollar weakness are associated with higher oil prices. Historically, a wide range of behaviour has been displayed. Data from January 1995 to October 2007 suggest that the relationship displayed little consistency over time.

For instance, between December 2004 and July 2005, a period of remarkable strength in the dollar, oil prices soared by 40 per cent. With history failing to show the existence of an unambiguous relationship between the dollar and oil prices, the proponents of this view have to base their argument on the presence of a fundamental rationale rather than on factual experience, it is argued.

It is known that a weaker dollar makes imports cheaper for the importing-consuming countries, while it squeezes profits for non-US producers-exporters. A weaker dollar makes oil cheaper for non-dollar consumers, whereas it squeezes profits for non-US producers, which should prove supportive for prices over time. While the magnitude of the effect is far from clear, its transmission would involve substantial time lags.

Pointing out that refiners are often insulated from fluctuations in the value of the dollar as both inputs and output are denominated in the same currency, and any knock-on effect induced by higher end-user demand would likely be in the region of quarters and years rather than days, Barclays Capital said it saw little substance to those explanations, which base the latest move-up in oil prices on the deterioration of the dollar.

On the other hand, the tightening of the physical market balance has a far better explanatory power. Of late, there is demand to shift to a different pricing system based on a basket of currencies. How feasible is this? While some producers have demanded a move away from the US dollar, some others are opposed to a change.

In the absence of non-US dollar alternatives (with the exception of yen-denominated contracts on the TOCOM) there is need to move away from current market mechanisms and set up a brand new pricing system, which may not be feasible. Barclays pointed out that while dollar movements raise the issue of managing oil revenues and reserves, their impact on the fundamentals of the oil market was limited.

From this perspective, the implication of a weakening dollar can be better addressed in the context of foreign exchange market, through the invoicing of oil in non-US dollar currencies and the diversification of reserves away from the US dollar assets, rather than through measures impacting the functioning of the oil market itself, it is argued.