Analys
Oil and Dollar – A self-reinforcing feedback loop
There is an intimate relationship between the oil price and the USD. Looking back at the crude oil price and the USD Index since 2013 they are mirror images of each other. We argue that it is not only a one way street from a weaker USD to a nominally higher crude oil price. There is also likely a link from a stronger crude oil price to a weaker USD as well. In addition we also have that OPEC & Co is forcing the oil price higher through their cuts while Donald Trump is promoting a softer USD amid a global economy which is reviving. We are currently in a Merry-go-round circle which is feeding on itself pushing crude prices higher, the USD lower which again is bullish for Emerging Markets which is bullish again for commodity demand,… If the circle is not stopped by verbal intervention from either OPEC & Co on the oil price or ECB on the Eurodollar side then this circle could spiral higher with Brent crude rising another 10% to $77/bl while the USD Index moves back to its 2014 level of 80 points. But both the dollar and crude prices are technically very stretch at the moment and ripe for corrections.
Price action – Higher on a softer USD and bullish WTI on Cushing draw
Yesterday the USD Index fell 1% while the Brent 1mth contract gained 0.8% to $70.53/bl. Brent crude thus actually fell 0.2% in real terms. The dollar was trading lower and lower all through the day. Brent crude also traded in bearish territory most of the day while it normally should have taken a bullish queue from the softer USD. The view that Brent has gone too far already probably weighted on the crude oil price. Brent was trying to move lower while the softening USD Index pulled stronger and stronger in the bullish direction.
Brent crude caved in to bullish push from the weaker dollar when the US inventory data came in at 16:30 CET. It showed that US crude stocks declined 1.1 m bl last week while the market had feared a gain of 4.8 m bl following the indicative numbers from API on Tuesday evening. Great relief. No decline. In addition the crude stocks in Cushing declined a full 3.2 m bl which gave a real boost to WTI crude prices relative to Brent crude. All in all for crude, gasoline and middle distillates there was a rise of 3.6 m bl which is not really all bullish. However, it was clearly bullish for WTI crude prices versus Brent and the whole mood just turned bullish. The Brent bears caved in to the bullish push from WTI and the strong bullish push from the weaker USD and up it went. This morning we have some follow-through as the USD Index declines another 0.2% while Brent trades 0.5% higher at $70.9/bl.
A higher crude oil price is dollar bearish – The feedback loop
A pure 50% devaluation of the USD would obviously lead to a doubling of the nominal crude oil price. The dollar is just a unit of measure. If the yardstick shrinks by 50% then the amount measured will have to double.
There is also another effect in reverse. If the crude oil price increases strongly then it is also dollar bearish and if it falls strongly it is dollar bullish. This is probably why we have such an incredible mirror image of the USD Index and the Brent crude oil price since 2013. The huge drop in the Brent crude oil price from mid-2014 was not driven by a weaker USD but by surplus crude and OPEC moving from a price game to a market share game.
In 2014 the US had a net petroleum import of 5 m bl/d and China imported of 6 m bl/d. Every dollar increase in the crude oil price results in a $4bn increase in the yearly expenditure of USD for China and US crude imports.
From mid-2014 the crude oil price moved from $110/bl to a low of $27/bl in early 2016. That is a decline of 83 dollar per barrel. If this difference sustained for a full year it would have and impact of $333bn. In comparison the US trade deficit is roughly $500bn per year. So the oil price drop equaled a 70% drop in the US trade deficit in terms of magnitude.
When the US spends USD on oil imports it receives crude oil and sends USD into the global market place. First into the pockets of global oil producers like Russia and OPEC. Then these dollars are spent in the global market place by them. A high crude oil price results in a larger flow of dollar from the US into the global market place and is thus dollar bearish. Russia for example will have a good dollar situation when the oil price is high as it receives a lot of USDs. A sharp decline in the oil price leads to less dollar being sent out of the US to global oil producers and into the global market place and is thus dollar bullish.
Most other countries than the US do not have this impact on the dollar cycle because they do not have dollar as their currency. When Europe for example purchases and imports crude oil it has to first buy the dollars in the global market place in exchange for euros. Then it spends the dollar for oil sending them to Russia and OPEC which then sends them back into the global market place when they spend it. Thus Europe’s oil imports are dollar neutral in terms of varying crude oil prices.
China is however a different case than most other countries. It has a dollar surplus to start with due to its trade surplus with the US. Normally this surplus of dollars are recirculated back into the US as China buys US treasuries, different bonds, equities or other US assets. A part of China’s dollar surplus is however spent on its crude oil imports and is thus fed to Russia or OPEC and then into the global market. China does not need to go into the market in the first place to purchase the dollar which it spends on crude oil imports. When the price of crude oil falls sharply then China will spend less of its surplus of dollar on crude oil and instead recirculate it back into the US by purchasing US assets. So a sharply lower oil price means China will feed a significantly lower amount of dollar into the global market place. Due to its dollar surplus and dollar recycling China is not dollar neutral in its crude oil import as Europe is.
The crude oil price has moved higher since early 2016 and sharply higher since June 2017. It has probably had an impact on the USD as it means a larger flow of dollar from the US and from China being fed into the global offshore dollar market via global oil producers like OPEC and Russia. It has relieved a dollar shortage among the world’s oil producers
At the moment there is thus likely a self-reinforcing cycle feeding a higher crude oil price and a softer USD. The USD is of course primed for weakness due to other reasons as well. That is also the case for Brent crude for which OPEC & Co has set the market up for tightness. So crude oil moves higher, the dollar moves lower which again implies a higher nominal crude price. The softer dollar is also EM bullish as it reduces their dollar payment burden of debt. So softer dollar leads to more bullish EM which again means stronger commodity demand and again a higher oil price. That’s a great Merry go round circle!
In the shorter term we are likely set for a correction in the dollar weakening. Verbal intervention from the ECB is probable. That would also likely be a trigger for a correction in Brent crude as it now has the most technically stretched level since 2011.
However, if there really is significant relationship going from the crude oil price to to dollar it means that the current crude oil price revival is now pointing us in the direction of a dollar Index level which we last saw back in 2014 which is another 10% lower at an index level of 80. A 10% softer USD also means a 10% nominally higher crude oil price. The current [oil to dollar] feeding cycle can thus go upwards/downwards to $77/bl for Brent crude oil and to 80 for the dollar index unless OPEC & Co stops the oil rally or the ECB stops the euro appreciation and the dollar weakening.
Chart 1: US dollar and oil – The mirror image
Chart 2: The market is tight as in 2013/14 shown by Brent spot versus Brent 1mth contract
Chart 3: Deliberate OPEC & Co production cuts of 2.1 m bl/d
Sum of cuts not including gains by Libya, Nigeria etc
Kind regards
Bjarne Schieldrop
Chief analyst, Commodities
SEB Markets
Merchant Banking
Brent touching down to the 200dma. Brent crude traded down for a fifth day yesterday with a decline of 0.4% to USD 70/b. This morning it has traded as low as USD 78.6/b and touched down and tested the 200dma at USD 78.6/b before jumping back up and is currently trading up 0.2% on the day at USD 79.1/b.
The Dubai 1-3mth time-spread is holding up close to recent highs. The 1-3mth time spreads for WTI and Brent crude have eased significantly. The Dubai 1-3mth spread is however holding up close to latest high. Indian refiner Bharat is reported to struggle to get Russian crude for March delivery (Blbrg). The Biden-sanctions are clearly having physical market effects. So, the Dubai 1-3mth time-spread holding on to recent high makes a lot of sense. I.e. it was not just a spike on fears.
US oil inventories may have risen 6 mb last week (API). Actual data later today. The US DOE will release US oil data for last week later today. The US API last night indicated that US crude and product stocks may have risen close to 6 mb last week. This may be weighing on the oil price today.
Brent and WTI 1-3mths time-spreads have fallen back while Dubai is holding up
Brent crude is no longer overbought. Down touching the 200dma before bouncing back up a lilttle.
Analys
Crude oil comment: Deferred contracts still at very favorable levels as latest rally concentrated at front-end
Bouncing up again after hitting the 200dma. Bitter cold winter storm in Texas adding to it. Brent crude continued its pullback yesterday with a decline of 1.1% to USD 79.29/b trading as low as USD 78.45/b during the day dipping below the 200dma line while closing above. This morning it has been testing the downside but is now a little higher at USD 79.6/b. A bitter cold winter storm is hitting Texas to Floriday. It is going to disrupt US nat gas exports and possibly also US oil production and exports. This may be part of the drive higher for oil today. But maybe also just a bounce up after it tested the 200dma yesterday.
Some of the oomph from the Biden-sanctions on Russia has started to defuse with arguments running that these sanctions will only delay exports of Russian crude and products rather than disrupt them. The effects of sanctions historically tend to dissipate over time as the affected party finds ways around them.
Donald criticizing Putin. Biden-sanctions may not be removed so easily. In a surprising comment, Donald Trump has criticized Putin saying that he is ”destroying Russia” and that ”this is no way to run a country”. Thus, Donald Trump coming Putin to the rescue, removing the recent Biden-sanctions and handing him a favorable peace deal with Ukraine, no longer seems so obvious.
Deeper and wider oil sanctions from Trump may lift deferred contracts. Trump may see that he has the stronger position while Putin is caught in a quagmire of a war in Ukraine. Putin in response seems to seek closer relationship with Iran. That may not be the smart move as the US administration is working on a new set of sanctions towards Iranian oil industry. We expect Donald Trump to initiate new sanctions towards Iran and Venezuela in order to make room for higher US oil production and exports. That however will also require a higher oil price to be realized. On the back of the latest comments from Donald Trump one might wonder whether also Russia will end up with harder sanctions from the US and lower Russian exports as a result and not just Iran and Venezuela. Such sanctions could lift deferred prices.
Deferred crude oil prices are close to the 70-line and are still good buys for oil consumers as uplift in prices have mostly taken place at the front-end of the curves. Same for oil products including middle distillates like ICE Gas oil. But deeper and lasting sanctions towards Iran, Venezuela and potentially also Russia could lift deferred prices higher.
The recent rally in the Dubai 1-3 mth time-spread has pulled back a little. But it has not collapsed and is still very, very strong in response to previous buyers of Russian crude turning to the Middle East.
The backwardation in crude is very sharp and front-loaded. The deferred contracts can still be bought at close to the 70-line for Brent crude. The rolling Brent 24mth contract didn’t get all that much lower over the past years except for some brief dips just below USD 70/b
ICE Gasoil rolling forward 12mths and 24mths came as low as USD 640/ton in 2024. Current price is not much higher at USD 662/ton and the year 2027 can be bought at USD 658/ton. Even after the latest rally in the front end of crude and mid-dist curves. Deeper sanctions towards Iran, Russia and Venezuela could potentially lift these higher.
Forward curves for Brent crude swaps and ICE gasoil swaps.
Nat gas front-month getting costlier than Brent crude and fuel oil. Likely shifting some demand away from nat gas to instead oil substitutes.
Brent crude was already ripe for a correction lower. Brent closed down 0.8% yesterday at USD 80.15/b and traded as low as USD 79.42/b intraday. Brent is trading down another 0.4% this morning to USD 79.9/b. It is hard to track and assign exactly what from Donald Trump’s announcements yesterday which was impacting crude oil prices in different ways. But crude oil was already ripe for a correction lower as it recently went into strongly overbought territory. So, Brent would probably have sold off a bit anyhow, even without any announcements from Trump.
Extending the life of US oil and gas. The Brent 5-year contract rose yesterday. For sure he wants to promote and extend the life of US oil and gas. Longer dated Brent prices (5-yr) rose 0.5% yesterday to USD 68.77/b. Maybe in a reflection of that.
Lifting the freeze on LNG exports will be good for US gas producers and global consumers in five years. Trumps lifting of Bidens freeze on LNG exports will is positive for global nat gas consumers which may get lower prices, but negative for US consumers which likely will get higher prices. Best of all is it for US nat gas producers which will get an outlet for their nat gas into the international market. They will produce more and get higher prices both domestically and internationally. But it takes time to build LNG export terminals. So immediate effect on markets and prices. But one thing that is clear is that Donald Trump by this takes the side of rich US nat gas producers and not the average man in the street in the US which will have to pay higher nat gas prices down the road.
Removing restrictions on federal land and see will likely not boost US production. But maybe extend it. Donald Trump will likely remove restrictions on leasing of federal land and waters for the purpose of oil and gas exploration and production. But this process will likely take time and then yet more time before new production appears. It will likely extend the life of the US fossil industry rather than to boost production to higher levels. If that is, if the president coming after Trump doesn’t reverse it again.
Donald to fill US Strategic Reserves to the brim. But they are already filled at maximum rate. Donald Trump wants to refill the US Strategic Petroleum Reserves (SPR) to the brim. Currently standing at 394 mb. With a capacity of around 700 mb it means that another 300 mb can be stored there. But Donald Trump’s order will likely not change anything. Biden was already refilling US SPR at its maximum rate of 3 mb per month. The discharge rate from SPR is probably around 1 mb/d, but the refilling capacity rate is much, much lower. One probably never imagined that refilling quickly would be important. The solution would be to rework the pumping stations going to the SPR facilities.
New sanctions towards Iran and Venezuela in the cards but will likely be part of a total strategic puzzle involving Russia/Ukraine war, Biden-sanctions on Russia and new sanctions on Iran and Venezuela. All balanced to end the Russia/Ukraine war, improve the relationship between Putin and Trump, keep the oil price from rallying while making room for more oil exports of US crude oil into the global market. Though Donald Trump looks set to also want to stay close to Muhammed Bin Salman of Saudi Arabia. So, allowing more oil to flow from both Russia, Saudi Arabia and the US while also keeping the oil price above USD 80/b should make everyone happy including the US oil and gas sector. Though Iran and Venezuela may not be so happy. Trumps key advisers are looking at a big sanctions package to hit Iran’s oil industry which could possibly curb Iranian oil exports by up to 1 mb/d. Donald Trump is also out saying that the US probably will stop buying oil from Venezuela. Though US refineries really do want that type of oil to run their refineries.
Big money and USD 80/b or higher. Donald Trump holding hands with US oil industry, Putin and Muhammed Bin Salman. They all want to produce more if possible. But more importantly they all want an oil price of USD 80/b or higher. Big money and politics will probably talk louder than the average man in the street who want a lower oil price. And when it comes to it, a price of USD 80/b isn’t much to complain about given that the 20-year average nominal Brent crude oil price is USD 77/b, and the inflation adjusted price is USD 102/b.
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