As a ceasefire nears, rising oil prices and increasing yuan-based trades challenge the dollar’s dominance.
Dubai: The global financial system’s dependence on the US dollar for oil trade is being tested in real time as the Iran war enters its second month, with attention now turning to a fragile two-week ceasefire window.
What began as a geopolitical shock has rapidly evolved into a deeper market shift, prompting investors and policymakers to reassess the strength of the petrodollar system that has supported global trade for the past five decades.
At its core, the petrodollar system is simple: crude oil is priced in US dollars, energy-importing nations need to hold dollars to purchase it, and oil-exporting countries reinvest those earnings into US assets.
That structure, formalized in the 1970s through agreements between Washington and Gulf oil producers, has long supported global demand for the greenback and strengthened the dollar’s status as the world’s reserve currency. The Iran conflict, however, has both reinforced and unsettled that system.
Oil and the dollar move together
Oil prices surged in the immediate aftermath of US and Israeli strikes on Iran on February 28, triggering a sharp repricing across currency and bond markets.
Brent crude climbed roughly 25% in the weeks that followed, while the US dollar strengthened against most major currencies. That correlation marked a break from the usual pattern, where rising oil prices typically put pressure on the dollar. Instead, both oil and the greenback moved higher together.
“Oil markets continue to set the tone in foreign exchange,” said Alex Cohen, a foreign-exchange strategist at Bank of America, pointing to recent price swings driven by developments around the Strait of Hormuz.
Costly oil boosts the US dollar
Strategists and investors say this shift reflects structural changes in the US economy, along with the mechanics of global oil trade. The US is now one of the world’s largest energy producers, making it less vulnerable to supply shocks that hit oil-importing economies much harder.
At the same time, because crude oil is still priced in US dollars, any sharp rise in oil prices increases global demand for dollar liquidity, further strengthening the greenback.
“Higher oil prices mechanically improve the US terms of trade and increase global demand for dollars for energy transactions,” said Neil Sutherland, a portfolio manager at Schroder Investment Management.
The result has been a renewed “petrodollar impulse,” with markets increasingly treating the US currency as a proxy for energy exposure. Some analysts have even described the dollar as a “petrocurrency” during the conflict, reflecting how closely it has tracked crude prices since late February.
War also exposes cracks
Yet the same forces strengthening the dollar in the short term are also revealing vulnerabilities in the system over the longer horizon.
The Strait of Hormuz, through which nearly one-fifth of global oil supply passes, has become a major focal point of both military and financial pressure. Disruptions to shipping have increased price volatility and pushed energy buyers to rethink supply chains and payment mechanisms.
Reports that Iran has allowed oil shipments to pass only if payments are made in Chinese yuan highlight a growing willingness to bypass the US dollar in strategic transactions. Indian refiners, for example, have recently been settling payments for Iranian crude in yuan through ICICI Bank’s Shanghai branch under a temporary US sanctions waiver, according to Reuters.
While still limited in scale, the shift is being closely watched by banks and policymakers as a sign of gradual de-dollarisation in global energy trade. It underscores how geopolitical tensions are pushing some countries to explore alternatives to the traditional petrodollar system.
Rise of the ‘petroyuan’ narrative
“The conflict could be the catalyst for erosion in petrodollar dominance and the beginnings of the petroyuan,” wrote Deutsche Bank strategist Mallika Sachdeva in a recent note.
China’s role is central to that possible transition. As the world’s largest buyer of Middle Eastern crude, Beijing has been steadily expanding the use of the yuan in energy trade, while also building payment systems that operate outside traditional dollar-based channels.
The Iran war has accelerated those efforts, giving both buyers and sellers stronger incentives to test alternatives to the dollar. At the same time, Gulf producers are also recalibrating their own positions.
Gulf states hedge their bets
Many oil exporters in the region now sell far more crude to Asian markets than to the US, weakening the historical alignment that once anchored the petrodollar system. Initiatives designed to enable cross-border payments without relying on the dollar—including multi-central bank settlement projects—are gaining momentum as a hedge against geopolitical risk.
Still, the dollar’s dominance remains firmly intact for now.
Most global oil contracts continue to be priced and settled in US dollars, and the depth of American financial markets provides a level of liquidity, trust, and stability that alternative systems have yet to match.
Markets reflect mixed signals
Market behavior during the conflict reflects that dual reality.
Investors have simultaneously sold US Treasuries amid inflation concerns linked to higher oil prices, while increasing their exposure to the dollar itself—a dynamic that highlights the currency’s enduring central role.
“Those are oil and the dollar,” said Nathan Thooft, a senior portfolio manager at Manulife Investment Management, describing the limited number of trades that have consistently worked during the volatility.
The longer-term outlook, however, remains far less clear-cut.
Long-term risks to a stronger dollar
Sustained high energy prices risk slowing economic growth in the US as well as abroad, potentially weakening the relative advantage that has supported the dollar’s recent strength.
“The US economy will likely see a decline in GDP growth as a result of higher energy prices that affect consumer spending, so it isn’t a net positive overall,” said Kathy Jones, head of fixed-income strategy at Charles Schwab.
For now, the petrodollar system is neither collapsing nor fully secure—it is adapting under pressure, shaped by a war that has once again placed oil, and the currency used to trade it, at the center of global markets.
Whether that pressure leads to lasting change will depend on what happens next—not just on the battlefield, but also in the currency used for the next barrel of oil traded.
