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Busting A Myth: U.S. Dollar Impact On WTI

Shale rig

How many times have you seen this: “Because the U.S. dollar is the quoted currency in oil, a stronger dollar buys more oil per dollar and causes the price of oil in dollar terms to fall. The opposite is true when oil rises.”?

This is called received wisdom, something so glaringly obvious that it doesn’t stand further scrutiny. Or does it?

Currently, the U.S. produces just over 9.1 million barrels per day (b/pd) of crude oil, the majority of it WTI or equivalent. Of that, only a very small portion is exported and is consequently subject to currency fluctuations. According to Platts, “While the U.S. will likely continue to import significant volumes of crude in the foreseeable future, the import/export balance is likely to see only moderate increases on the export side from the current 600,000 b/d, given economics and logistical limitations.” Taking the Platts export number as a benchmark, that represents only about 6.5 percent of daily U.S. production that must be purchased with foreign currencies, assuming that these exports are destined for delivery to non-US$-denominated areas (i.e., the crude is not going for example to St Croix in the US BVI.) The possibility also exists that exports can be re-exported imports.

Even if exports from the U.S. do increase substantially in the future, we’re still probably talking about no more than 10 percent of WTI purchases having any sensitivity to currency movements because WTI (unlike Brent) is a U.S.$-denominated commodity purchased with U.S. dollars in the U.S. and not with foreign currency translated into U.S. dollars from buyers around the world.

The Other Side of the Currency Equation

So when the U.S. Federal Reserve Board (FOMC) raises interest rates, what effect will that have on the price of oil? Again, the received wisdom is that when the value of the U.S. dollar increases, the global price of oil drops, because oil is bought and sold in U.S. dollars. A more valuable dollar buys more oil. Conversely, a weaker dollar buys less oil, so when the dollar depreciates, the global price of oil rises. The assumption therefore is that higher rates equate with a higher dollar and that translates into lower crude oil prices. Speculators in the WTI futures contract can therefore be expected to behave accordingly. Related: Why Shell’s Oil Sands Sell Off Is Great News For Canadian Oil

But do higher rates really impact the cost of a U.S.$-denominated commodity bought and sold in U.S. dollars? Certainly, the dollar comes into play as higher interest rates affect the cost of carry or the investment leverage factor, which is then reflected in the futures basis (the difference between a commodity’s spot price and that reflected in the futures price.) In addition, currency plays a role in spread trading between WTI and Brent and in other forms of arbitrage in the overall energy complex. “Currency” also plays a role in WTI pricing to the extent that prices paid at the well-head and Cushing can vary dramatically; but that’s a question of how many dollars are on the table, not how much the dollar is worth. It’s also salutary to remember that the underlying price structure for WTI and Brent is anything but monolithic (see Oil Prices Beyond WTI And Brent By Drilling Info) But otherwise, rates and the projected value of the dollar aren’t really that relevant. In other words, neither factor is very useful in accurately forecasting the direction of the price of WTI. For that, you have to look to more basic fundamental issues such as supply/demand equilibrium, technical factors and charting, and the omnipresent headline-seeking algorithmic traders.

The Usual Suspects

If WTI were priced in euros or even against a basket of major global currencies like the U.S. Dollar Index (DXY), then U.S. dollar strength and changes in U.S. domestic interest rates would indeed be key factors in any discussion of the price of crude. But in the case of WTI, it may be that newspaper headline-writer laziness more than anything else is responsible for propagating the too familiar shibboleth: the dollar is higher today, and that’s why crude is lower. Maybe it’s time for the media to change its tune.

By Brian Noble for Oilprice.com

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  • Me on March 22 2017 said:
    Pure crapola. Who tries to analyze the impact of USDX on oil without taking into account the fiat nature of the so-called "dollar" (post Nixon's default on the gold standard)? The dollar is a myth...they print it at will. It's worth on the international market is/was tied to US troops in the Persian Gulf protecting those who supply oil...priced in dollars to the world market. Those days are over...oil is now priced in many currencies...
  • John Scior on March 23 2017 said:
    You have two items being exchanged both obeying the laws of supply and demand. The reasoning behind the myth is that when US interest rates go down, there is a contraction in the money supply ( by means of money multiplier inherent in the US lending system ) hence a smaller supply of dollars means the value of the dollar goes up so that anything purchased with it, including oil, (assuming a static supply and demand for that item ) becomes less expensive per dollar. The problem lies in that oil has its own supply and demand determining its value as well. For example, the dollar has increased in value since the start of rising interest rates but because of OPEC agreement to curtail production ( a contraction of the supply curve ) we see a nominal raise in price per barrel.
  • Mud on March 24 2017 said:
    The US is not the only consumer of international oil. Globally over 90% of the oil sold is in US currency. If you buy oil from Angola or Nigeria or Saudi Arabia or UAE and export it to The Netherlands you will be buying the oil from the exporters in USD and selling it to the refineries in an agreed currency. Sometimes it is Euro,USD , Swiss Francs depending on the contract with the refiner. Noone is buying Saudi crude in their own currency. There isnt enough in circulation. Same as in most oil export countries. The oil price is pegged to the USD value whether you like it or not. Also to your point about US oil exports. I guarantee you that the US exporters are not receiving Pesos for oil. PEMEX is paying them dollars.

    On another note the service companies working for the Oil Exporters also get paid in dollars. If i send a vessel to work for Aramco i will charge and get paid in dollars. Even service companies working in Iran were getting paid in dollars during the embargo.

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