How the Fed could drive oil prices down more

Oil prices could be facing a significant jolt after Federal Chair Janet Yellen, in her annual speech at the Jackson Hole economic symposium in Wyoming, said that the case to increase interest rates had strengthened. The extent of the jolt that may be felt is far from certain, however.

Due to the quotations of crude oil in U.S. dollars, there is often a bind between the fate of the greenback and the costs of oil per barrel, as the balance of oil trade and the effect on market psychology can be hugely influential.

There are, however, other significant factors in the oil price equation, including high production rates and inventories.

Spencer Welch, director of downstream energy consulting at IHS Markit explained that “a rate hike would strengthen the U.S. dollar, which would make oil more expensive globally, so this would tend to reduce oil demand slightly, but it takes a while for this effect to play out, and would therefore likely reduce oil market price.”

“By how much? That depends on the size of the interest rate increase. It is likely to be less than $1/bbl in oil price impact, but that is not based on historical statistics.”

Different nations Welch believes, are effected by a rate rise in varying ways, depending if they are net exporters or importers of oil.

Importers are more likely to be hurt by a rate rise as oil would become more expensive due to a rising dollar, net exporters of oil would benefit as a result of selling oil in dollars, with the dollar being stronger.

“I would say yes, rate rise impacts are smaller compared to other oil market impacts, such as declining U.S. oil production, high oil inventories, high oil production rates in other countries, including production in Saudi Arabia, Russia, Iraq, Iran, and in the North Sea.” Spencer Welch continued.

A recent paper by Morgan Stanley highlighted that the correlation between trade weighted U.S. dollars and oil was high until May this year, when large supply outages and then product market concerns subsequently brought oil back into focus, due to the increased market anxiety.

The investment bank also points out that in July, the oil and dollar price association was disrupted by fears of product overhang, although recently there are signs that the correlation is returning.

If this relationship stays firm, then Morgan Stanley believes that this could help support oil prices in the near term. Overall the bank’s forex team sees the dollar weakening further, before resuming an upwards trajectory next year.

The paper also points to how global market factors can have a huge impact on oil prices, outweighing the influence of a rising or falling dollar, as evidenced by the influence of the upcoming OPEC meeting taking place alongside the International Energy Forum in Algiers.

Any production deal to combat oversupply in the market must engage with Iran’s conditional demands, that OPEC will have to agree to allow it to return to its pre-sanction production levels.

Morgan Stanley also said that even if the meeting is a successful one, an OPEC freeze would likely be a short term positive but a medium term negative for oil prices.

Other factors such as the United States’ burgeoning production of shale oil has also been mentioned as a game changer for the oil price and dollar relationship, as argued by Goldman Sachs’ Jeffrey Currie in a study published in 2014.

He said that in 2008 the U.S. was importing on a net basis nearly 12 million barrels per day of oil and products. Today, owing largely to shale technology, that number is less than 5 million barrels per day, disturbing the oil price and dollar correlation.

According to the United States Energy Information Administration, the volume of shale oil production peaked at 4.5 million barrels of oil per day in early 2015, before falling to 4 million a day this year.

It’s uncertain by how big a margin shale oil production has transformed the oil price and dollar relationship, as the United States remains a net importer of oil.

OilPrice.com is a USA TODAY content partner offering oil and energy news and commentary. Its content is produced independently of USA TODAY.


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