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Schork Oil Outlook: The Dollar / Oil Relationship

Yesterday’s (Monday's) intra-day charts show a strong inverse relationship between USDEUR and Nymex WTI, as illustrated in today’s issue of The Schork Report.

Yet traders may be hesitant to trade this correlation consistently due to its historical tendency to break down. For instance, the dollar rallied 14.96% against the eEuro between November 2009 and July 2010, while front month WTI also rose 2.16% over the same timestep.

More recently, the dollar fell 2.26% in January while WTI was on track to fall 6.28% over the month (before, of course, Egypt happened). Due to the volatile news cycle, the correlation between WTI and USDEUR stands at just -0.106 as of writing, as compared to a much stronger -0.924 in November 2009.

The question now is whether this correlation will strengthen or weaken. Consider that yesterday several OPEC nations such as Kuwait and Nigeria joined Saudi Arabia in increasing crude oil production. The increase is expected to be felt by the start of April, bringing enough barrels on the market to outweigh disruptions in Libya.

If OPEC has the ability to move the market, OPEC is also severely attuned to the dollar. A weak dollar means OPEC nations receive less in real terms for their crude oil, creating an incentive to produce more oil. Nations within the producer group are already exceeding self-imposed quotas. Latest estimates have OPEC’s compliance around 53%.

If the dollar is high, they can afford to cut back output. Producers do not have this option if the dollar is low. With headlines pushing OPEC oil above $110 and a weak dollar, producers will most certainly produce even more.

Analyst Hamza Khan of The Schork Report advises that how much crude we have, and its price, will likely be highly correlated to the dollar going forward.

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Stephen Schork is the Editor of The Schork Reportand has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.