Dollar and Oil Prices

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Earnings, oil prices, strong dollar coupled with ECB and BOJ accommodation are just the economic volatility in the market. Then we have ISIS, Ebola, Ukraine, and Hong-Kong vs. China, which has not really impacted market fundamentals or global trade. Yet with all this uncertainty and potential volatility in the market, the one factor that can cool all of it is the Federal Reserve monetary policy, which we will know in a couple of days. It needs to be accommodative and dovish, but not too much of a shocker to over-shadow the mid-term elections. Just enough to smooth over the volatility for now.

Dollar and Oil Prices

Ever since the dollar has been floated, unpegging it from a fix gold price of $35 an ounce (the gold standard) in 1971, it has become unofficially pegged to oil. The United States was fortunate in some respects not only being the world’s reserve currency but also the currency used to price most of the world’s oil. Our relationship with Saudi Arabia has been an awkward one, but one that has also secured oil prices and given the dollar value. All the smaller nations of the world that rely on oil imports buy and hold U.S. dollars as a hedge against their own currency, in order to purchase oil without the currency risk. This has given rise to what is known as the Petro-dollar, the value of the dollar and its strength as it relates to the oil trade.

New Oil!

Looking at traditional oil (both proven and unproven reserves) we had started reaching “peak oil” a couple of years ago. Saudi Arabia and other OPEC nations were running very close to maximum extraction rates, while global consumption continued to rise. The good news is that technology has helped access reserves deeper in the ocean and also from sands and shale that was either too difficult before or far too costly to extract.

The technology to access the deeper oil, sands and shale comes with a hefty price tag. The climb in oil prices have made accessing this oil profitable and has seen a booms in areas like North Dakota and deep waters in the Atlantic. These new booms have seen measurable increases in oil productions which has in some respects narrowed the gap between the global rates of consumption vs. production.

Courtesy of wikipedia

All business is driven by profit margins. More profits and better margins means new technologies, expansion, new competition, and more jobs and better paying jobs. One only needs to visit or read up on the boom in North Dakota.

Is it Supply & Demand?

If we look at oil in the supply and demand equation from the big picture, we see that oil supplies have picked up in North America. This has certainly help off-set some of the supplies from traditional OPEC and outside producers. However on the global picture the North American increase in production has not narrowed the gap between supply and demand, it has only slowed it. The growth in the emerging markets, when measuring consumption rates is still growing at a rather significant rate.

From the OPEC, US SPR, and Euro Zone oil consumption rates, coupled with the emerging markets, there is no resounding proof that we are in an over-supply situation that is driving down oil prices. The growth rate of demand is still pacing with production levels.

I have heard economist point to demand slack in Europe or North America as a reason and while these are large markets, they are not THE market in its entirety. Adding in the BRICS and the booming rise in South East Asia, we see the Western slack quickly disappear and global consumption on the rise.

Courtesy of wikipedia

OPEC Squeeze?

Oil is priced, traded, and exchanged (for the most part) in dollars. Many OPEC members continue to trade oil with U.S. bilateral nations in U.S. dollars. However, with the advent of the BRICS coming forth as a new political and economic partnership, we have seen more and more oil priced out of dollars in trade. Not only has many OPEC members traded and priced oil in none U.S. dollars, the BRICS have been moving towards their own New Development Bank, which has discussed pricing oil in anything but U.S. dollars.

Courtesy of wikipedia

This conjecture at best, but some believe that OPEC (mainly Saudi Arabia) is helping pressure oil prices lower to strain U.S. shale productions in order to see were break-even is. We know that shale and sands are far more expensive to produce, many in the oil business like to base margins on the price per barrel. At what price per barrel does it become unprofitable to extract oil from shale or sand? Is it $80, $75, $70? The speculative consensus by oil analyst is that shale/sand production costs is at $75 a barrel.

Dollar Strength?

The recent rise in the dollar, which is a culmination of central bank policies in the West (nothing more), is certainly a contributing factor to the decline in oil prices. This can make it all the more confusing for domestic production vs. imports vs. domestic consumption. At what price do oil imports become attractive over domestic sand/shale production? With a strong dollar and oil priced in dollars we see an interesting conundrum between consumption vs. production location. Obviously a stronger dollar will eventually make imports far more attractive to domestic consumers, shifting our reliance back to imports. Yet, a stronger dollar also can backfire for OPEC, as they ship out more oil and get back fewer dollars.

The Currency War

We know the Western Central Banks are in a race to devalue their currency and boost exports, pay off debt, and hope to create domestic jobs in their respective nations. With the dollar being buoyed it has certainly hobbled U.S. exports and domestic job creation, but has the added benefit of increasing buying power and lowering oil prices.

For now the BRICS and OPEC have been on the outside looking in on this rather silly devaluation war among the western central banks. These central bank policies of the west have done and continue to do more long-term economic damage themselves than the BRICS could ever hope to imagine. However, with the BRICS falling into two camps (Brazil and Russia oil producers with China and India being oil consumers) this recent rise in the dollar and the impact to oil prices can pull the BRICS into this currency war and may likely ramp up their position in the New Development Bank and bringing OPEC under their wing of re-pricing global oil out of the U.S. dollar.


This ripple effect of the strong dollar is bringing forth some strained relations not only among the West, but also among the BRICS. At some point either the U.S. will take action to reduce dollar strength and begin more accommodation or we may see a combination of the BRICS (with their New Bank) and/or OPEC take a more direct approach. I believe the ripple effects of the devaluation currency war in the West has unintended consequences that could put the petro-dollar at risk. Something needs to break, either dollar weakness again or a move by the BRICS/OPEC.

We may get a glimpse of what will happen next with the FOMC meeting this week and how oil prices and dollar strength reacts. You know my position; I believe that the Fed will take a dovish tone with hints of more accommodation.

We are seeing an interesting move in the Copper market this morning as a single firm buys up 50% of the copper. Is someone betting on a weakening dollar, as copper like oil, is predominately priced in or against dollars? Single Firm Holds more than 50% of the copper in the LME Warehouses.

Support & Resistance

INDU 16,600 – 16,800
We could break-out this week after the FOMC statement. Any strong tone either hawkish or dovish will drive this market out of this range. Prepare for a strong move.

NDX 3950 – 4050
This index has made a jolting move higher and we could be pending a break-out with a dovish Fed that could see 4100 by week’s end. However, any trepidation or hawkish town can send this index down sharply to 3900 or lower.

SPX 1940 – 1960
This maybe the consolidation zone until Wednesday. We could see a pull back to the 1920-1930 level in the short-term. I would look at 1980 and even 2000 a possibility on a strong dovish tone with accommodation implications by the Fed. The VIX should stay in the 16-20 range until the Fed speaks, then we will see either 12-13 if the S&P rallies or 30 in a sell-off.

RUT 1100 – 1120
The Russell continues to be the best gauge to the market. I think we really need to wait for the FOMC statement to see where to next. However, the RUT and the bonds are pricing a more accommodative Fed.

Tail wags the dog!

The Fed’s monetary policy (ZIRP and QE) is the tail that wags the dog (oil/dollar/inflation). I don’t believe that Supply & Demand alone are driving oil prices, there just doesn’t seem to be enough evidence.

I guess we will only know who is running the show after the FOMC statement and IF there are any measurable or substantial changes. We should expect to see a move in the dollar, which will trickle over to commodity prices, the dollar, inflation, trade, bond market, and equity markets.

The Fed is and has been in far more control of the economic story then what we would like to believe or would hope.

5 Responses to “Dollar and Oil Prices”

  1. Bob Lucas says:

    Michael, As an oil guy I like your 1000 foot view. Too many people are reacting to the oil drop as if it means there is a major glut. In the short term there has been more oil in the pipeline with all the domestic crude being produced, and as winter approaches we have a normal seasonal adjustment in oil prices as travel slacks off and usage drops. However, nothing changes the long term oil picture in which supply and demand are moving to problem levels. The IEA predicts by 2020 we have serious shortfalls of production against usage worldwide.

    Also the price is of interest. MOST of the new finds, such as in North Dakota, are a lot more costly to produce. As an example my research uncovers that Exxon’s average price to extract and create oil to sell is $77 a barrel… (Far above our $25 a barrel price in SE KS) This means as oil prices drop we will get to a point at which production slows due to the economics of it, and of course in time the extra oil in the pipeline diminishes creating a price increase to cover the cost of getting more oil production back in service… The recent price drop has more to do with the politics of oil producers than supply and demand. OPEC is doing what they can to not lose their control. But this won’t last forever.

    • Thanks for the detailed information about the production in North Dakota. That seems in line with what I have heard in the $75 range. I believe the dollar is playing a crucial role in pricing at this point.

      • Jason Hoppe says:

        I just find it funny that the price has dropped as much as it has, in short term, right before the elections. I think it has a lot more to do with political schemes than actual economics. I would believe in a short time after the elections, the price will be right back up near $90 a barrel pretty quick. Just my opinion.

  2. McRocket says:

    Thanks for this.