The Petrodollar Loop

Petrodollars, simply defined, are oil revenues denominated in U.S. dollars. The petrodollar loop is essentially the global practice of pricing oil exclusively in U.S. dollars rather than any other currency and having those dollars recycled into U.S. assets.

So, no matter what country is buying oil, they pay the oil-producing country in petrodollars denominated in U.S. dollars. Petrodollars accrued to oil-exporting nations depend on the sale price of oil as well as the volume being sold abroad, which is in turn dependent on oil production. These U.S. dollar reserves are then reinvested in U.S. assets, primarily Treasuries. The system has maintained low borrowing prices for American consumers and the U.S. government throughout the years.

But as the Iran War has further shaken the Middle East and Gulf states, this petrodollar loop has been weakened, if not entirely broken, since the loop requires two moving parts—dollars accrued and dollars invested—and both have stopped flowing, along with the oil normally shipped through the Strait of Hormuz.

The Petrodollar Loop

The petrodollar loop is a Cold War-era stabilizing agreement negotiated in reaction to an early 1970s oil embargo by the Saudis and their allies in the Organization of the Petroleum Exporting Countries (OPEC), as well as an attempt by the United States to counter the threat of encroaching Soviet influence in the region. The financial arrangement was negotiated in March 1974 by then-Secretary of State Henry Kissinger with the Saudi king. Following a multibillion arms deal by the U.S. with Israel after the October 1973 Yom Kippur War, the Saudis and their fellow OPEC members had instituted an oil embargo. 

In return for arms and a security guarantee negotiated by Kissinger, the Saudis and eventually other Gulf states agreed to price crude only in U.S. dollars and reinvest the dollar surpluses in U.S. assets, primarily Treasuries. Though the petrodollar agreement originally only applied to Gulf states and members of OPEC, it has been broadened over the years.

The arrangement with oil-exporting nations eventually became a global, self-reinforcing loop: Because the petrodollar is denominated in U.S. dollars, the system results in oil-producing countries ending up with surpluses of U.S. currency that need to be recycled back into the economy.

Petrodollar recycling can involve channeling these dollars back into their own domestic economies, lending them to other countries, or investing them. Countries can use the dollar surplus to buy assets and securities such as Treasuries, helping to keep interest rates and inflation low and allowing those countries to avoid currency conversion losses and risks.

For 50 years, this petrodollar loop subsidized American borrowing costs and cemented the dollar’s role as the world’s reserve currency, maintaining high demand for greenbacks and allowing the U.S. to borrow at low costs.

A Kink in the Loop

The Iran War has fractured this arrangement. Oil-importing nations such as Turkey, India, and Thailand are in a bind: Oil priced in U.S. dollars has surged past $100 a barrel while other currencies weaken against the greenback. To limit depreciation—which would push domestic oil prices even higher, forcing either fiscal subsidies or household pain —central banks intervene in currency markets. This requires dollars, and the most liquid dollar asset any central bank holds are Treasuries. So, the central banks sell.

Accordingly, after the war began on Feb. 28, foreign central banks were net sellers of Treasuries for five consecutive weeks. Holdings at the Federal Reserve Bank of New York dropped by roughly $82 billion to $2.7 trillion, the lowest level since 2012. The 10-year Treasury yield, rather than falling on safe-haven demand as it has in every major recent crisis, climbed from 3.9% at the end of February 2026 to above 4.4% within weeks.

Central banks have intervened in foreign exchange markets to prop up their currencies, a move that typically involves selling U.S. dollars (DXY) and the Treasury securities they hold. Oil importers such as Turkey, India, and Thailand are likely among those selling as they pay higher dollar-denominated prices for oil. These countries don’t want their currencies to weaken further because it will push up the local currency price of oil. 

This situation is not unprecedented. Foreign central banks sold a record $109 billion in Treasuries when the global COVID-19 pandemic broke out in March 2020. To resolve this, the Fed deployed dollar swap lines; the money soon flowed back. Every other major crisis since—Russia’s invasion of Ukraine, China’s saber-rattling against Taiwan in August 2022, the collapse of Silicon Valley Bank in March 2023 and the October 7, 2023, attacks on Israel by Hamas—resulted in money going into Treasuries, not out. Yields fell.

Where the Oil Goes (or Doesn’t)

Meanwhile, for oil exporters, in a normal oil shock, rising prices would generate rising revenues for Gulf producers, with petrodollars flowing back into dollar-denominated assets, including Treasuries. High oil prices have historically been, paradoxically, supportive of the Treasury market. The shock creates the surplus that generates demand for the bonds.

But this time, Gulf producers can’t get their oil out. The Strait of Hormuz closure has stranded their barrels along with everyone else’s. Gulf states collectively cut production by at least 10 million barrels per day in March 2026.

The Saudis, Kuwait, and the UAE had a combined holding of about $300 billion in Treasuries as of January 2026. The Saudis and the United Arab Emirates (which has since departed OPEC) have alternative pipelines through which to export oil, but at reduced volumes. Those routes handle only about a quarter of what normally flows through the Strait at full capacity and are still threatened by Iranian drone and missile attacks. The Gulf Cooperation Council’s economic model has effectively seized up.

Where the Oil Comes From

The U.S. has become less reliant on Gulf oil compared to its dependence during the 1970s. Thanks to the domestic shale production, the U.S. now stands as the world’s leading oil and gas producer while it sells more energy products than it buys.

The U.S. imported 84.26% of its oil from the Western Hemisphere in 2025, which marked its highest import proportion from that region and established a ninth straight year of record imports from that area. The United States receives 6% of its crude oil imports through the Strait of Hormuz.

Middle Eastern oil sources provide Asia with about 60% of its oil needs, which creates major risks for the entire region. The U.S. still imports oil from the Saudis but at a significantly lower volume. By contrast, China has become the Saudis’ largest oil customer, accounting for more than 20% of the kingdom’s oil exports.

Shaky Treasuries, Eroding Dollar

There is a longer structural story that the war is accelerating rather than creating. The share of Treasuries held by foreign investors had already fallen to around 32%, down from half in the early 2010s. Central banks became net sellers in early 2025. For the first time since 1996, global central banks now hold more gold in aggregate than U.S. government bonds. Foreign central banks will not abandon Treasuries wholesale. No other market offers the depth, liquidity and legal infrastructure that central banks require.

But in previous global crises, the U.S. has been a stabilizer, not a combatant. But now the U.S. itself is a belligerent, driving the oil shock, straining Gulf relationships, and generating fiscal pressure that has bond investors worried about US budget deficits.

The dollar maintains its reserve status despite the petrodollar loop showing signs of decline. Some believe that it is more important that computer chips are traded in U.S. dollars than that oil from the Gulf region is traded in U.S. dollars.

In 2026, Russian oil is primarily purchased using non-dollar alternatives to bypass Western sanctions, with China’s yuan and the United Arab Emirates’ dirham being dominant for international transactions. India, a major buyer or Russian oil, settles trades using Indian rupees, which are then converted into dirhams or yuan. Indian refiners are increasingly settling purchases of Russian oil in alternative currencies, as they seek to reduce reliance on the dollar amid rising geopolitical tensions and shifts in U.S. policy.

In 2026, amid the war with Israel and the United States, Iran is actively using the Chinese yuan to sell its oil, particularly as a toll for passage through the Strait of Hormuz. This shift, sometimes called the petroyuan, allows Iran to avoid U.S. sanctions by settling transactions directly through Chinese systems.

Venezuela began selling its oil in other currencies, and the Saudi government has threatened to abandon petrodollars. As the energy market evolves, the agreement that created the petrodollar system may come to an end.

Dan Steinbock, the founder of the consultancy Difference Group, said that while the supremacy of the U.S. dollar would not change in the short-term, the growing use of yuan could “chip away” at U.S. dominance in specific sectors over time. “Overall, it is a question of gradual erosion rather than an abrupt substitution,” Steinbock told Al Jazeera.

Conclusion: Watching the Numbers

The U.S. dollar currently accounts for 88% of global foreign exchange transactions, and 54% of global trade. It also accounts for 58% of global foreign exchange reserves, down from 71% in 1999.

In addition, the foreign-held share of U.S. Treasuries has also decreased from nearly 50% in the early 2010s to about 30% as of April 2026. Moreover, an increasing share of foreign holdings of Treasuries comes from private foreign investors, who may be more sensitive to changes in yields and whose demand for Treasuries may thus be more fickle than foreign central banks and other institutional or government-based holders.

If the U.S. dollar’s primacy further declines—an uncertain, but possible, prospect—the U.S. government would likely face higher borrowing costs and increased fiscal pressure, with spillover effects for private financial markets, households, and businesses. 

As always, if you have any questions about this report or any other questions, please reach out to Bowen Asset at  info@bowenasset.com or (610) 793-1001.