For months now, members of the Organization of Petroleum Exporting Countries and many western analysts have blamed the weak US dollar as a primary cause of the escalation of oil prices. “It’s not because of a lack of crude on the market,” they claim, although demand growth has been rampant in India and China.
As oil prices recently peaked at record highs, the US dollar fell to record lows against other key currencies as the Federal Reserve Bank lowered interest rates to stave off inflation and cushion the US credit crunch. In the process it has lowered the cost of oil to many foreign buyers and has encouraged investments in crude as a hedge.
In its largest 3-day price fall ever, the front-month crude contract lost $15.89 over July 15-17 to close at $129.29/bbl on the New York Mercantile Exchange. The dollar rallied July 17 from earlier losses, but then turned slightly weaker against the euro.
That same day, the Centre for Global Energy Studies (CGES), London, reported, “The falling value of the US dollar may have had a marginal impact on the price of oil, but it is clearly not the prime driving factor, and OPEC’s assertion that prices are reacting to the euro-dollar exchange rate is really just another way of saying that it is all down to speculation, while ignoring their own role in the process.”
Certainly, there is a high degree of correlation between the price of oil in US dollars and the exchange rate between the dollar and euro. On a monthly average basis from January 2002 through mid-July 2008, “the correlation coefficient between the two is around 0.8,” CGES reported. “If we concentrate only on the period since January 2007, this rises to 0.95–very high indeed–and strong evidence, surely, that OPEC has got it right.” However, the analysts asked, “Is this evidence really compelling enough?”
Between January 2002 and the first half of July 2008, the value of the US dollar fell from 1.132 euro to 0.634 euro, a lost of nearly 45% of its value. “Over the same period, dollar-denominated oil prices have risen from $18.42/bbl to $137.57/bbl for OPEC’s reference basket of crudes, an increase of almost 650%. The rise in the oil price over this period has far surpassed the fall in the value of the dollar,” said CGES analysts.
Moreover, they said, “Neither the run-up in oil prices between May 2004 and September 2006, nor the surge since January 2007, was accompanied by any appreciable increase in the rate of the dollar’s slide in value against the euro.” Focusing on the most recent period of soaring oil prices since the start of 2007, CGES analysts said, “The argument weakens even further. Over this shorter period, the value of the dollar has fallen by around 20% against the euro, while dollar-denominated oil prices have increased by more than 170%.”
Comparative correlations
The correlation of comparative monthly changes in both the dollar’s value and the price of oil “is not good,” CGES officials said. In fact, over the period of January 2002-July 2008, they said, “There is no correlation at all, while for the period since January 2007 the correlation is considerably weaker than that between the absolute values, with a coefficient of around 0.57.”
Then there is the matter of timing. Analysts said, “The biggest month-on-month jump in oil prices so far this year occurred in April, when the price of the OPEC basket leapt by 14%. In that same month the value of the US dollar rose against the euro, suggesting that there were other factors at play in driving the oil price upwards. Actually, since March of this year the dollar has been remarkably stable against the euro on a monthly-average basis, yet oil prices have risen by almost 40%.”
If oil prices really are being driven upwards by the falling value of the dollar against the euro, analysts said, “Then we would expect the euro-denominated price of oil to be much more stable than the dollar-denominated price. To a degree this is indeed the case.” From January 2002 through mid-July 2008, the dollar-denominated price of the OPEC reference basket of crudes increased 650%, while the euro-denominated price rose 320%. “The euro-denominated oil price may not have been rising as dramatically as the dollar-denominated price, but it was far from stable,” analysts said. “Since the beginning of 2008, the dollar has lost 8% of its value against the euro, while the dollar-denominated oil price has risen by 58% and the euro-denominated price is up by 46%.”
(Online July 21, 2008; author’s e-mail: [email protected])
