By STEVE AUSTIN for OIL-PRICE.NET, 2016/05/11
Crude oil was at a 13-year record $25 low in mid-January 2016 and has soared more than 70 per cent since. The battle is on again. We are talking about the mighty forces whipping up the oil prices. How does the investor work out where the oil price will go? Ultimately, you have to make your own forecasts, at least on the general, long term direction of oil prices – short term movements tend to be driven by news stores on the day. In particular, you need to take into consideration the following dimensions:
– Supply and demand: if producers are outstripping demand, prices will fall and if there is a shortage of oil, prices will rise.
– Political events: a war, rebellion or political uncertainty affecting major oil producers may prevent those countries from producing and selling, reducing the supply of oil.
– Economic growth: if demand is expected to grow faster than production, excess supply will be soaked up and shortages will arise.
– Related markets: the futures market, availability of transport, currency rates and the cost and of extraction equipment and labor can all affect the price of oil.
We took these factors into consideration when assessing six reasons for the recent rise in crude oil prices. Will this rally continue, or has the price peaked?
Weaker dollar raises oil prices
The market price of crude oil is valued in US dollars. Therefore, when the oil price falls or rises, you also need to look at the value of the dollar against a range of currencies. If an oil refinery in China needs to buy crude oil, it has to convert its income, derived in the local currency, Yuan into dollars. An oil producer, such as Saudi Arabia, needs to convert its income into the local currency, the Riyal in order to cover its costs. Large buyers go direct to suppliers in order to get a good price for their oil. China is particularly adept at this practice and has written up agreements to pay in its own currency for crude oil, rather than in dollars. So, if the value of the dollar falls by 10 per cent, the contract price of those agreement rises by 10 per cent, even though it hasn’t changed at all in the contract currency.
In fact, this phenomenon is notable in all commodities priced in dollars – steel, copper, gold, and silver have all experienced price rises in 2016. This is not because there is a shortage in those commodities; it is just because the currency in which they are priced has fallen. Continue reading →