Oil and Gas

Weak Dollar Central to Oil Price Boom


The weak dollar's leading role in oil's ascent to record highs is partly due to a tide of financial flows into commodity investments but also reflects a shift in the greenback's relationship with crude.

Gas prices in the northwest section of the District of Columbia at this Exxon Gas Station are seen at more than $3.25 per gallon, Saturday, May 19, 2007, in Washington. A cash crunch is fast approaching for the government trust fund that pays to build and repair highways and bridges. The federal tax on a gallon of gas has not risen in 14 years and Congress is reluctant to increase it. People are demanding more fuel-efficient vehicles _ less gasoline used, fewer dollars for the fund. (AP Photo/
Haraz N. Ghanbari

The dollar has traditionally influenced the price of oil and other commodities, including gold and base metals, which are mostly priced in the currency and usually move to compensate for changes in the its value.

So the steep fall in the dollar to record lows against the euro, for example, has helped drive oil to a record of $83.90 a barrel, reached on Sept. 20.

"I'm certainly in the camp of dollar weakness driving crude strength," said Anatol Feygin, head of global commodity strategy at Bank of America.

"With growing OECD inventories, revised lower demand, increased OPEC production and a relatively mild hurricane season, the dollar seems to be much more the issue."

That, analysts say, is because one aspect of its longstanding relationship with oil is changing.

In the past, dollars earned by oil producers flowed into U.S. dollar assets or investments.

The Gulf countries are thought to hold around $3.5 trillion in total dollar reserves, according to Lehman Brothers research.

But investors say the proceeds from the current oil boom -- petrodollars -- have not gone to support the U.S. currency.

"The petrodollars which historically got invested back in the U.S. in dollar-denominated investments now have more options back home or in emerging markets or the euro," said Badung Tariono, who manages an energy fund for ABN AMRO.

"The relative stability of the euro and good opportunities in the rest of the world play a large part as well," he said. The Qatari-backed investment fund Delta Two, for example, is in talks to buy British food retailer J Sainsbury for about 10.6 billion pounds ($21.34 billion).

The Quatar Investment Authority is vying with Borse Dubai and Nasdaq to buy Nordic exchange OMX.

Oil Prices Could Rise Further

"After a generation on the sidelines, the dollar has re-emerged as an upside risk to oil prices," Lehman Brothers said in a research note.

An influx of hedge funds, banks and other financial institutions into the commodity markets in the past few years has also had an impact on oil/dollar moves, analysts say.

"You have more financial players today that are trading oil and commodities and they will play more of those micro-relationships," said Olivier Jakob of oil consultancy Petromatrix.

"If you are bearish the dollar you can sell the dollar index or buy oil and gold or commodities to diversify your portfolio," he said.

The dollar index, a tradeable instrument which tracks its move versus a basket of six currencies, is close to record lows.

Commodities have moved into the spotlight as an asset class because of a price boom but also because they behave differently from stocks and bonds and so offer diversification.

Long-only money invested in commodities indexes, for example, reached $120 billion by the second quarter of 2007, a 50 percent increase on the same point in 2006, according to statistics from AIG Financial Products.

Turbulence in equity and debt markets caused by banks drawing in their horns because of bad loans in the U.S. mortgage sector has played a part in attracting money into oil.

"Crude oil has benefited from funds diverted from elsewhere during the recent financial market uncertainty," Helen Henton, head of commodity research at Standard Chartered, wrote in a research note.