A new driver of oil prices has emerged lately — a weaker US dollar. Since crude’s crash in 2014 the conversation about oil markets has been dominated by basic topics such as balances of supply and demand, shale drilling and Opec policy, or sales of SUVs versus electric vehicles.
Now, a long-held if tenuous relationship: the lower the dollar goes, the higher oil prices tend to go, is attracting renewed attention on Wall Street. So far this month, the dollar index has dropped more than 3 per cent, plumbing its lowest level since December 2014.
West Texas Intermediate crude was trading above $65.21 a barrel on Monday afternoon, the highest since December 2014. The revived currency focus could shift the dynamics of energy markets as funds slosh in from money managers betting on crude based on beliefs about macroeconomic trends. Such flows can overwhelm fundamental data on oil balances, at least in the short term.
Money managers have accumulated a record net bullish position worth 550m barrels in WTI crude futures and options, according to government data released on Friday. “The trade that existed at least two years back, it basically disappeared,” says Olivier Jakob of Petromatrix, a Swiss-based oil consultancy. “The glut was so significant that it made no sense. Now, some of it has come back.”
The trade has come back to a changed world. Thanks to shale exploration, US crude oil production is poised to break records by surpassing 10m barrels a day this year, the Energy Information Administration forecasts. The country’s net imports of crude oil and petroleum products fell below 2.5m b/d late last year, the lowest in records dating to the early 1970s.
The US’s shrinking size as a monster oil importer suggests the impact on the dollar should be different than it was, say, in 2008, when oil prices surged above $145 a barrel and the trade-weighted dollar index skidded to the lowest in decades. “It is a new era,” says Akito Matsumoto, senior economist at the International Monetary Fund. “The shale revolution has changed the market structure.”
Oil is internationally traded in dollars. In the past, a higher global oil price would worsen the US oil trade balance, putting pressure on the dollar as it was used to pay foreign suppliers.
This effect will be muted as US net petroleum imports decline, says Mr Matsumoto, who serves as acting chief of the commodities unit in the IMF research department. A higher oil price tends to stimulate more US production, further offsetting its need for imports, he says.
The fact that the dollar and US oil have both returned to the levels of three years ago is likely a coincidence, Mr Matsumoto says: “It’s more the oil side has an oil story and the dollar side has a dollar story. They just happen to be in the same direction this time.”
Indeed, the dollar may be weakening partly because economic growth is taking hold in Europe, Japan and much of the rest of the world, enabling central bankers to look at ending stimulus efforts and lifting interest rates. These moves should increase the value of their local currencies.
The broad growth identified by the IMF and others also has a bullish effect on oil prices as fuel consumption rises. World oil demand will reach 99.1m b/d this year, up 1.3m b/d on last year, the International Energy Agency estimates.
For countries whose currencies have strengthened against the dollar, oil prices in local money are not moving up as fast as in dollars, softening the impact on consumers, Bank of America Merrill Lynch says.
Bruno Braizinha, a strategist at Société Générale, says tightening monetary policy outside the US is generally bearish for the dollar. “It’s bullish for the broader commodity complex.”
Also, the fact that the Fed has been measured in raising interest rates buoys the economies of emerging markets — the countries underpinning oil demand growth. Still, Mr Braizinha says: “The dollar is a driver of the broader commodity complex, but every commodity has its own idiosyncratic factors.”
The dollar could easily rebound, with consequences for the oil market. BofA strategists warn of a sharp rally in the coming months as money is repatriated to the US following federal tax reforms in the country. The bank projects average prices of $60 a barrel for WTI and $64 for Brent, its international counterpart, in 2018.
Source: FT.com
