The Dollar and Oil
After enjoying a stellar run-up, crude futures are headed south again, hovering at three-months lows. However, the fundamentals of supply and demand may not be the key reason behind the recent bout of weakness in crude futures.
Read Futures Movers Natural-gas prices jump 8%; oil logs 6th straight session loss
U.S. benchmark oil, West Texas Intermediate trading on the New York Mercantile Exchange CLU6, -1.98% has lost nearly 15% of its value so far in July, as of Thursday.
Back on June 8, WTI had nearly doubled its value closing at a 2016 high of $51.03 a barrel after reaching a low of $26.21 on Feb. 11.
What a difference seven weeks can make.
The change in direction has industry specialists like those at Morgan Stanley pointing to “worrisome trends” and forecasting crude prices to resume a fresh decline—possibly to as low as $35 a barrel for the second half of 2016.
Read: How made-up earnings make things tricky for investors
Also read: Fed appears more willing to lift interest rates in September
Morgan Stanley, in a Sunday research note, argues that positive tailwinds that have underpinned the recent rise in crude prices, namely a reduction in supply and output problems, are fading. Morgan Stanley describes the headwinds for crude this way:
Supply continues to return from disruptions, refined products are severely oversupplied, crude demand is falling well short of product demand, and key product demand is decelerating. Our revised below-consensus GDP outlook, macro risks and longer positioning in oil markets only add to downside risks.
Morgan Stanley points out that one of key issues for crude is a severe oversupply of refined products from crude, namely gasoline, while demand is waning. “Refined product glut and market share battle will weigh on crude oil. An overcorrection in crude oil demand from refiners is needed to clear product market overhangs,” researchers at Morgan Stanley, led by economist Adam Longson, wrote.
Supply disruptions such as a workers’ strike in Kuwait, wildfires in Canada’s oil sands, and attacks in Nigeria have been notable.
Check out: These 3 charts show the beginning of the end for Wall Street’s big winners
But those issues abate, a glut of oil-product supplies, rising U.S. crude production and fears of anemic global growth have been blamed for the tumble in crude futures.
However, looking beyond basic supply-demand factors, the U.S. dollar DXY, -0.13% has one of the biggest influence on moves in WTI crude since the oil grade hit its June 8 high. Since that period, the buck has gained about 3.8% while crude futures have fallen about 17% (see chart above).
“Global growth doesn’t really have an impact on oil in the short run. What does move around a lot is the U.S. dollar,” said Binky Chadha, chief global strategist at Deutsche Bank, who believes the dollar has helped to dictate oil. Chadha said global growth, valuations for oil futures and the dollar are three main variables that influence oil moves.
The fact that the buck has influenced crude prices in that way isn’t surprising, but the degree to which the currency weighs on oil is sometimes striking.
Commodity prices are inversely correlated to the dollar. The oft-cited rationale is that a stronger currency makes dollar-pegged commodities, like oil, more expensive to buyers using other currencies.
Read: How the S&P 500 performs on Fed decision days
Also read: Why gold prices spiked after the Fed decision
Uncertainty in the global financial world also has jostled oil prices around, with events like the U.K. vote to exit the European Union resulting in a rout of so-called risk assets, including oil and global equities.
“The U.S. dollar always has an impact on crude. [Dollar] strength on crude will provide a stiff headwind for crude oil even if fundamentals on crude are strong,” said Tariq Zahir, managing member of commodity-trading firm Tyche Capital Advisors LLC.
“In this instance with U.S. rigs building, Nigerian and Canadian oil all getting back online and supplies at record levels, the U.S. dollar gaining strength is not only providing a headwind but helping crude in its current weakness,” Zahir said.
Crude’s weakness wasn’t helped by data on Wednesday from the U.S. Energy Information Administration that showed crude inventories rose 1.7 million barrels for the week ended July 22, with gasoline supplies up 500,000 barrels, reinforcing the view that high gasoline inventories are dragging crude futures lower, despite a summer period in the U.S., which should pull stockpiles lower.
Coincidentally, the dollar’s influence on oil is one factor Morgan Stanley’s Longson cited back in January as a threat to higher crude prices. Back then, Longson stated that because there is “no intrinsic value” to crude oil in an oversupplied market, oil tends to be vulnerable to currency gyrations.
And continued worries about oversupply seem like exactly the dynamic the crude-oil market is wrestling with again. That may be especially the case as the Federal Reserve opted to leave rates unchanged on Wednesday but hinted that it might be inclined to raise interest rates in September, citing improved economic conditions.
After enjoying a stellar run-up, crude futures are headed south again, hovering at three-months lows. However, the fundamentals of supply and demand may not be the key reason behind the recent bout of weakness in crude futures.
Read Futures Movers Natural-gas prices jump 8%; oil logs 6th straight session loss
U.S. benchmark oil, West Texas Intermediate trading on the New York Mercantile Exchange CLU6, -1.98% has lost nearly 15% of its value so far in July, as of Thursday.
Back on June 8, WTI had nearly doubled its value closing at a 2016 high of $51.03 a barrel after reaching a low of $26.21 on Feb. 11.
What a difference seven weeks can make.
The change in direction has industry specialists like those at Morgan Stanley pointing to “worrisome trends” and forecasting crude prices to resume a fresh decline—possibly to as low as $35 a barrel for the second half of 2016.
Read: How made-up earnings make things tricky for investors
Also read: Fed appears more willing to lift interest rates in September
Morgan Stanley, in a Sunday research note, argues that positive tailwinds that have underpinned the recent rise in crude prices, namely a reduction in supply and output problems, are fading. Morgan Stanley describes the headwinds for crude this way:
Supply continues to return from disruptions, refined products are severely oversupplied, crude demand is falling well short of product demand, and key product demand is decelerating. Our revised below-consensus GDP outlook, macro risks and longer positioning in oil markets only add to downside risks.
Morgan Stanley points out that one of key issues for crude is a severe oversupply of refined products from crude, namely gasoline, while demand is waning. “Refined product glut and market share battle will weigh on crude oil. An overcorrection in crude oil demand from refiners is needed to clear product market overhangs,” researchers at Morgan Stanley, led by economist Adam Longson, wrote.
Supply disruptions such as a workers’ strike in Kuwait, wildfires in Canada’s oil sands, and attacks in Nigeria have been notable.
Check out: These 3 charts show the beginning of the end for Wall Street’s big winners
But those issues abate, a glut of oil-product supplies, rising U.S. crude production and fears of anemic global growth have been blamed for the tumble in crude futures.
However, looking beyond basic supply-demand factors, the U.S. dollar DXY, -0.13% has one of the biggest influence on moves in WTI crude since the oil grade hit its June 8 high. Since that period, the buck has gained about 3.8% while crude futures have fallen about 17% (see chart above).
“Global growth doesn’t really have an impact on oil in the short run. What does move around a lot is the U.S. dollar,” said Binky Chadha, chief global strategist at Deutsche Bank, who believes the dollar has helped to dictate oil. Chadha said global growth, valuations for oil futures and the dollar are three main variables that influence oil moves.
The fact that the buck has influenced crude prices in that way isn’t surprising, but the degree to which the currency weighs on oil is sometimes striking.
Commodity prices are inversely correlated to the dollar. The oft-cited rationale is that a stronger currency makes dollar-pegged commodities, like oil, more expensive to buyers using other currencies.
Read: How the S&P 500 performs on Fed decision days
Also read: Why gold prices spiked after the Fed decision
Uncertainty in the global financial world also has jostled oil prices around, with events like the U.K. vote to exit the European Union resulting in a rout of so-called risk assets, including oil and global equities.
“The U.S. dollar always has an impact on crude. [Dollar] strength on crude will provide a stiff headwind for crude oil even if fundamentals on crude are strong,” said Tariq Zahir, managing member of commodity-trading firm Tyche Capital Advisors LLC.
“In this instance with U.S. rigs building, Nigerian and Canadian oil all getting back online and supplies at record levels, the U.S. dollar gaining strength is not only providing a headwind but helping crude in its current weakness,” Zahir said.
Crude’s weakness wasn’t helped by data on Wednesday from the U.S. Energy Information Administration that showed crude inventories rose 1.7 million barrels for the week ended July 22, with gasoline supplies up 500,000 barrels, reinforcing the view that high gasoline inventories are dragging crude futures lower, despite a summer period in the U.S., which should pull stockpiles lower.
Coincidentally, the dollar’s influence on oil is one factor Morgan Stanley’s Longson cited back in January as a threat to higher crude prices. Back then, Longson stated that because there is “no intrinsic value” to crude oil in an oversupplied market, oil tends to be vulnerable to currency gyrations.
And continued worries about oversupply seem like exactly the dynamic the crude-oil market is wrestling with again. That may be especially the case as the Federal Reserve opted to leave rates unchanged on Wednesday but hinted that it might be inclined to raise interest rates in September, citing improved economic conditions.
