The relationship between the dollar depreciation and the rise in crude oil prices
Walid Khadduri Al-Hayat - 04/05/08//
Last week, OPEC's current chairman, Algeria's Minister of Energy and Mining Shakib Khalil, said "the dollar is now the barometer of oil prices," and anticipated that oil prices would jump from their current level of about $120 per barrel to almost $200. In his statement to the press he explained that oil prices move in an opposite direction to the dollar and hence a direct relationship exists between the two. As an example, he added, the dollar appreciated by 1% a few days earlier while oil prices dropped four dollars per barrel, and if the dollar appreciated by 10%, oil prices would fall by $40. If the dollar stayed stable at its current level, oil prices will also stay stable between $80 and $110. He concluded his statement by saying that everything depends on the movement of the dollar which remains the barometers to future developments.
The dollar is in a continuous cycle of decline as it lost a quarter of its value against the Euro over the past two years. It has also weakened further with the decisions of the Federal Reserve to cut interest rates to support the American economy. These decisions, as it is well-known, have global implications as their effects are not limited to the American economy alone. Many nations and people all over the world have been influenced by the depreciating dollar, not to mention the rise in oil prices.
In its last World Economic Outlook report, the International Monetary Fund reached conclusions similar to those stated by Khalil. The IMF confirmed that in the long term, a 1% decline in the dollar value is equivalent to an increase of over 1% of gold and oil prices. In the short term, the relation is closer to 1%, although higher for gold than for oil. According to the report, moreover, an experts meeting has reached the consensus that the recent surge in oil prices compensates for a weak dollar.
The weakness of the dollar is attributed to many factors. Most of important of these is the slowing economy in the US where major economic sectors (including American and European banking sectors in addition to the American real estate sector) were influenced by developments in the US since the last fall. Stock markets have lost almost 15% of their value since last October while the prices of commodities have been up by the same rate during the same period.
These opposite trends are the result of attempts by investors and speculators to escape the effects of inflation and the declining dollar by resorting to oil and gold. By doing so and pumping billions of dollars out of the stock market, they are effectively weakening these markets while at the same time pushing the prices of oil, gold and commodities upwards at a rate that far exceeds the equilibrium between the demand and supply of these commodities.
the International Energy Agency which includes twenty-six industrial member states and whose mission is to defend energy consumers warned against the dangers of inflation and a weak dollar on oil prices in its last monthly report on oil markets. The IEA encouraged energy producers and consumers to work together to improve market transparency to reach a better understanding of the causes responsible for the current record prices. It is worth mentioning that OPEC states have also recently called for a higher level of market transparency to improve the understanding of these markets. Currently, OPEC publishes significant statistics on its member states that previously were not available.
What happened is that markets have been turbulent since the war on Iraq in the spring of 2003, and prices have risen to record levels at rapid rates. Additionally, the basic characteristics of the oil market have changed significantly to the extent that much of the analysis has become mere speculation and guesswork.
The question that many economic and oil experts still struggle to answer is: how big and deep is the American economic crisis, what are its implications for the oil market and other commodity markets, how far will the cycle of dollar depreciation and rising oil prices continue, and what are the upper and lower limits to both?
*Energy Expert
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