Reality Hits Oil Market, Dollar Could Benefit

Even though the lack of meaningful US economic data has kept the US dollar in flux, there is one commodity that is continuing to grind lower. Oil prices fell to the lowest level in 20 months as exporters wake up to reality that crude prices may stay at current levels for some time.

For the currency market, the decline in oil prices is bullish for the US Dollar, and Japanese Yen but bearish for the Euro and Canadian dollar. The weakness of US stocks will also add pressure on high yielding currencies Since the beginning of the year, there has been a 70 percent positive correlation between the EUR/USD and the price of oil.

With the fear of weakening global demand keeping oil prices under pressure, OPEC nations are starting to realize that production cuts may not be the answer. The strong rise in commodity prices that we have seen throughout 2006 and into the summer of 2008 was driven by the frothy expectations that the global economy will continue to expand at a healthy pace. That of course has been proved to be false.

Now that oil prices have dropped more than 50% since the summer and have refused to recover, oil exporters have resorted to hedging their oil exports at sub-$100 levels. The front page story in the Financial Times Tuesday talks about how Mexico, the world’s sixth largest oil producer is hedging nearly all of next year’s oil exports. This is a clear sign that they fear oil prices will remain below $70 a barrel in 2009. Even though the report only talks about Mexico, we doubt that they are the only oil producing country to start hedging.

In order to hedge against a drop in oil prices, oil producers need to enter into derivative contracts that basically involve selling oil prices forward.

Source: GFT Dealbook

Comments

[jepittman:]

The world economy needs lower oil prices. Petroleum costs are embedded in somewhere in virtually every product and service. Lower costs will cushion the economic decline.

2008 Nov 11 10:40 AM

[Greg Pinelli:]

Ms. Lien has it precisely backwards..the dollar isn't necessarily benefitting from lower oil..it is the CAUSE in large part of lower oil. Refuge capital is taking money from everywhere and shovelling it into US dollars...the financial disarray and the evident recession worldwide IS the cause of lower oil prices (one can include whatever speculative unwinding one wants in that equation..20% sound reasonable?).
A couple of token remarks concerning reality..first..the US $ is only "strong" because almost every other currency is worse off..However! the notion that a country that throws TRILLIONS at bailouts and stimulus packages can possible harbor sound money is absurd.
Second...oil wil remain low until investors wake up to the notion that producers will provide only the bare minimum..AND NO..AS IN NONE!..NEW PROJECTS WILL GO FORWARD. That includes pipelines to transport the stuff. Good luck piling back in then..you'll need a crowbar to get thru the door.

2008 Nov 11 11:09 AM

[blu:]

Georealist is right.
The lower oil prices go from here, the higher they will go in the near future.
OIl prices will continue to be highly volatile now that "peak oil" has been reached.
This downturn in oil prices, while appearing quite nice now, is only temporary.
It is a great opportunity to play the swing.

2008 Nov 11 04:17 PM

[sickofthehype:]

Oil is priced in dollars, and since July our dollar has gained a ton of strength. Strong dollar, low oil. Look at the index from July to present.

But now we must factor in a 38% increase in money supply in only a few months, plus all of the stimulus packages in place and READY to be placed (just watch), as well as watch this continuing game of who-can-debase-their-c... game being played by the G20.

I wouldn't base my investment theories alone on Mexico's decision to hedge. That's muy loco. This inflationary campaign is about to hit LIKE NO OTHER, so be ready for it. Oil will shoot up in a very, very short period of time, just like it came down in a short amount of time.

2008 Nov 11 06:02 PM

[Alex Kateb:]

I agree with Georealist. From a rational economic point of view, the correlation between oil and the dollar goes from strong dollar to weak oil and NOT the opposite.

I don't know if we already reached "peak oil" but what is sure is that the world still relies heavily on oil and OPEC will control 50% of oil production in the near future up from 40% today. This is all the more true as major non-opec oil producers such as Russia (which produces the same amount as Saudi Arabia) have started to invest in oil production only in 2006-2007. This means new Russian oil output will not be on the market before a decade maybe.

Besides, the incremental demand for oil comes from China not from the US and China will consume more and more oil in the coming years. Don't get fooled by all the "renewable/clean energy" mantra. Every reasonable expert and analyst predicts that oil demand will grow considerably. Peak demand for oil will not be reached before 2 or 3 decades.

In the short term, oil demand will be reduced due to the recession and the market may overshoot on the downward side as well as it overshoot on the upward side in the summer. The price of a barel could fall to as low as 30 USD a barrel somewhere between now and H1 09 and there will surely be a lot of volatility but I expect the price of oil to bounce back to 100 USD a barel in H2 09. If I were an oil trader I would play the overshooting by selling (being short on) June 09 futures and buying (being long on) December 09 futures.

2008 Nov 12 09:14 AM

[Richard Col...:]

We could end the recession and put people to work almost immediately if we started building tracks for a bullet train across country.
However I don't believe the unions , the auto industry or the oil companies would allow Washington to do anything to destroy their nest egg.
I also believe the American worker is too lazy to work hard. It's too easy to get Government handouts.

2008 Nov 12 10:06 AM

[CJ-49:]

Crude Oil: It was massive market manipulation and extortion. Hopefully the scammers are still in the market and getting theirs royally and deep deep up theirs... Am loving every minute - all the way down to $40 per barrel. Dare I hope $25? Oh such joy in the gloating.

As for you lot up there with your 'peak oil' and 'supply and demand' BS. Get this, BS is all it is and you are either the scammers or just brainwashed.

2008 Nov 12 12:31 PM

[the_lazy_ob...:]

you're right. oil is taking a nosedive not primarily because of weak global demand (the world is using just as much oil as before, if not more). the reason oil prices are decreasing is because the credit available to buy up all those speculative oil bets have gone dry.


On Nov 11 11:09 AM Georealist wrote:

> Ms. Lien has it precisely backwards..the dollar isn't necessarily
> benefitting from lower oil..it is the CAUSE in large part of lower
> oil. Refuge capital is taking money from everywhere and shovelling
> it into US dollars...the financial disarray and the evident recession
> worldwide IS the cause of lower oil prices (one can include whatever
> speculative unwinding one wants in that equation..20% sound reasonable?).
>
> A couple of token remarks concerning reality..first..the US $ is
> only "strong" because almost every other currency is worse off..However!
> the notion that a country that throws TRILLIONS at bailouts and stimulus
> packages can possible harbor sound money is absurd.
> Second...oil wil remain low until investors wake up to the notion
> that producers will provide only the bare minimum..AND NO..AS IN
> NONE!..NEW PROJECTS WILL GO FORWARD. That includes pipelines to transport
> the stuff. Good luck piling back in then..you'll need a crowbar to
> get thru the door.

2008 Nov 12 12:44 PM

[the_lazy_ob...:]

oil is lower because credit is drying up. the extraordinary rise in oil prices was fuelled by speculation, which is funded by cheap credit. with the credit crunch, all that is drying up. if the speculators can't find cheap credit, or in fact ANY credit, to buy oil, the prices will probably go down to a more realistic level -- prices before the credit bubble era.

2008 Nov 12 12:53 PM

[WayneS:]

USER218405 - I think the auto industry and oil companies would benefit greatly from a bullet train. Also stopping cross country inefficient semi truck/trailers. Rail is three times more efficient than truck. A lot of vehicles would need to be built to construct the rail. Eventually, oil companies could cut back on low margin gasolines and diesels (they lost money most of this year) and produce money-making products in their refineries.

2008 Nov 12 02:01 PM

[fatpitch2:]

The IEA has released its latest report --- It says peak oil won't get here until 2030 ... That's the headline anyway.......

When you read the rest of the article it says we only need to spend $1T+ per year and (unless you're a bank in trouble I don't see anybody getting ready to spend $1T a year on recovering more oil in a declining market...)

Oh yeah, and IEA says we need to go find 64 million barrels of oil equivalent a day of additional gross capacity between now and 2030 --- the equivalent of six times the amount Saudi Arabia produces today!

Piece of cake???? mmmmmmmmm I think not ....
Why invest in rigs and exploration ....

I think we will see declining supply soon -- production coming OFF-line shortly as the marginal cost is above market price this coupled continued yr-over-yr increases in world-wide demand for oil will (yes WW demand is still increasing even in this crappy envronment) ...

This will NOT be pretty ...

2008 Nov 12 02:08 PM

[Mark Anthony:]

That's a piece of complete nonsense. You talk about supply and demand, but have you cited one single number either on the supply side or on the demand side? Do you know about Peak Oil?

For 99% of analysts, when they talk about supply and demand, they always talk about demand side and never talk about supply side. And when they talk about weakening demand, all there is is just guess and speculation, no concrete number.

Here is one piece of numbers for you on the demand side, in the USA:
tonto.eia.doe.gov/dnav...

Compare the gasoline consumed in the first 8 months this year with that of last year, the number is 2.205136B barrels versus 2.261672B barrels, a mere 2.5% drop. Of course if you look at emerging economies, the number must be a significant increase. But even in the USA, the drop is only 2.5%, a very insignificant percentage.

On the supply side, do NOT under-estimate the destructive effect of rapidly plummeting oil prices on the producers. Even during good times in the early half of the year when oil price was twice current level, XOM's net profit is only 1/7 of its sales revenue. Now the revenue is probably halved as price is halved, while the cost remains the same, oil producer may not even be profitable any more. This removes a great amount of incentive to develope new oil sources.

Peak Oil is real. Mexico's Cantarell, second largest oil field in the world, is declining at an annual rate of 25% or higher. Mexico is now still the second largest oil supplier to the USA. But by as early as 2011 or 2012, Mexico will cease to be an oil exporter and will have to import oil for its domestic use!!! All of the top ten of the world's largest oil fields are declining rapidly. This decline can not be replaced if there is no high oil price to stimulate strong interest to look for dwindling remaining oil reserves in the next few years.

Read more why supply destruction in commodities is taking place:
seekingalpha.com/autho...

The commodity bull shall return with even more fierce forces soon, as severe damage to supply has already been done.

2008 Nov 12 09:46 PM