Investing

Tuesday, April 27, 2004

The Price of Oil Relative to the US Dollar

I have seen many articles refer to the fact that oil prices have increased because of the fall in the US dollar. This implies that oil behaves somewhat like a currency or gold and that as the US dollar falls Oil becomes more expensive as does gold or Euros. This sounds reasonable on the surface and here are a couple of links in which this is mentioned:

http://www.polkonline.com/stories/040404/opi_oilpricerise.shtml - "Between the end of February 2002 and the end of February 2004, the price of oil in dollars rose by 51 percent (from $20 a barrel in 2002 to more than $35 a barrel today), but it rose by only 4 percent in euros. Over the same two-year period, the value of the dollar plunged from 1.16 euros per dollar to 0.80 euros per dollar. In this situation, it is perfectly rational for foreign suppliers of oil to charge more in dollars to make up for the falling value of our currency." " It may seem like a stretch to blame the price of oil on fiscal mismanagement, but the rising price of oil is closely tied to the falling dollar, " - this has been republished by many other newspapers

http://www.ntrs.com/library/econ_research/daily/us/dd021004.pdf -- "Why do I blame the Fed for this? Because the Fed controls the supply of dollars in existence. And a depreciating dollar implies that there are too many dollars in existence. So, if the Fed had printed fewer dollars in the past, the dollar would not have depreciated and the price of oil would be coming down, not staying high." -- this is from Northern Trust Company.

"WTI crude oil forward prices are currently at or above US $28 barrel through 2008 on the NYMEX. Some of this indicated price appreciation in crude oil may reflect compensation for the falling value of the US dollar, but I believe as many others do that we have also entered a new era of crude oil supply and pricing." - MARCEL R. COUTU, President & Chief Executive Officer, Canadian Oil Sands Limited.

Of course the corollary is also quite reasonable. That is, the US dollar rises when the US economy is strong. When the US economy is strong demand for oil increases and with the increased demand comes higher oil prices.

As there seemed to be no research into the subject I took data from early 1983 for oil prices and a weighted index of the US dollar against a basket of currencies. You would expect to see a negative correlation of oil prices increase with a decrease in the dollar. In fact the correlation was positive and nearly .6. This would seem to indicate that a rising US dollar, which we may be about to see with interest rates rising, should cause oil prices to move even higher.

This bodes very well for an investment in Canadian Oil Sands (COSWF, COS_u.TO).

posted by Neil  # 12:47 AM

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