The US dollar's dominant position in the oil market is facing structural challenges, as trade patterns in the Gulf are undergoing a shift.

Investing.com - As the Gulf oil-producing countries shift their trade patterns and adjust their military spending priorities, the long-standing dominance of the US dollar in the global energy market is facing a structural reevaluation, and the “petrodollar” status is being challenged.

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According to UBS Chief Economist Paul Donovan’s latest analysis, while “resistance to change” remains a strong support for dollar-denominated oil, the economic incentives that once reinforced this relationship are gradually weakening.

This shift comes at a critical moment for global liquidity, as regional conflicts escalate, forcing major exporters to reconsider how they reinvest their substantial energy revenues.

Erosion of the “Mechanical Moat”

Historically, the role of the dollar as the primary currency for oil pricing was a mechanical inevitability; from the 1870s to the 1950s, the US produced over 50% of the world’s crude oil and supplied most of the extraction equipment. Oil-producing countries needed dollar revenues to settle dollar-denominated capital expenditures. However, this “mechanical moat” has been significantly weakened.

In Saudi Arabia, the US market share in total imports is now less than two-thirds of what it was a decade ago, hovering around 8%. As Gulf countries increasingly source industrial goods from a broader range of global partners, the functional need to hold dollars for trade settlements is diminishing.

Military procurement has traditionally been the last pillar of dollar demand in the region, with Gulf budgets heavily tilted toward US defense giants. However, UBS notes that if regional powers begin to diversify their military spending following recent hostilities, the motivation to receive and hold dollars could further decline.

A complete abandonment of the dollar is unlikely to happen immediately, but a “dual-track” spending pattern—where oil is priced in dollars but the resulting income is immediately sold for other currencies—could exert new downward pressure on the dollar.

Recycling of Income in the Post-War Economy

For investors, the “interesting question” is no longer just how oil is priced, but where the surge in energy revenues flows. Due to instability in the Persian Gulf, oil prices remain high, and the amount of dollars flowing into oil-producing countries’ treasuries has surged.

In previous cycles, this “petrodollar recycling” provided reliable demand for US Treasuries. Today, the shift of Gulf sovereign wealth funds toward domestic infrastructure and non-Western military equipment suggests that “dollar selling” may become an inevitable secondary transaction following crude oil price surges.

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