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Focus: Transportation Management

Feature Article from Our Transportation Management Subject Area - See All

From SCDigest's On-Target E-Magazine

April 27, 2011

 

Logistics News: Behind Rising Oil Prices, Everything but Supply and Demand

 

Speculation Adding 20% to Cost, Goldman Sachs Says, but That is Connected Directly to Falling Value of the US Dollar

 

SCDigest Editorial Staff

 

A funny thing happened on the way to the price per barrel of oil soaring past $110 recently: it has little to do with supply and demand.

Oil prices have spiked in the last six months, up some 22% in 2011 alone, causing pain in corporations and households alike. Diesel fuel prices have risen to over $4.00 per gallon in most areas of the US, up more than $1.00 from a year ago. Rising oil prices not only hit the cost of transportation, but the price of many purchased inputs that are themselves impacted by rising oil and transportation costs.

SCDigest Says:

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The impact of speculation cannot be understood without understanding the role of the value of the US dollar...For the past six months or so, the value of the US dollar has been falling significantly against most major currencies
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But as many commentators have noted, the market equilibrium for oil has not reallychanged over the past year. The world is still producing about 86 million barrels of oil per day. The balance of demand and supply saw little or no change during this huge price run up, and interestingly the world has thus far seen little of the "demand destruction" most expected as the cost of oil ran up over $100.00.

So, what going on? Well, as in the last oil price explosion, "speculation" by oil traders is blamed, but maybe with even greater validity today.

A recent report by the analysts at Goldman Sachs said that as much as 20% of the current price of oil - or around $20.00 per barrel - might be attributable to the role of speculation and oil futures rather than marketplace dynamics. The report noted that speculative interest in oil right now is four times as high as it was in June of 2008, just one month before the peak oil price of almost $150.00 was reached in July of that year.

But the impact of speculation cannot be understood without understanding the role of the value of the US dollar. Today, oil is traded globally in US dollars. For the past six months or so, the value of the US dollar has been falling significantly against most major currencies, especially the Euro, the Japanese Yen, and the Chinese Yuan.

So, oil buyers in other countries could in effect buy oil more cheaply because they get more dollars and oil for the same amount of Yen or Euro as the dollar falls. Or, those buyers - whether they be refiners or speculators - can pay more for a barrel in dollar terms but be paying the same in their own currencies.

Rising oil prices also allow producing countries to keep "whole" in real terms when they are being paid in dollars that are worth 20% less today than they were six months ago.

During the last big oil run up of 2007-08, a number of analysts produced charts showing the inverse correlation between the value of the dollar and the price per barrel of oil. As the value of the dollar declined, the price of oil rose in near lock step.

"The US dollar has been the main oil price driver for most of the last several years and the inverse relationship between the US dollar and oil and commodity prices has been exceptionally strong," says Dominick Chirichella, a writer for the International Business Times. "The US dollar has been faltering versus most major currency pairs, with the US dollar Index now trading at the lowest level since around August of 2008.

(Transportation Management Article Continued Below)

 

CATEGORY SPONSOR: SOFTEON

 

 

Jeff Morris, CEO of Dallas-based Alon USA, a major refiner and marketer of petroleum products as well as a large 7-11 store franchisee, recently said, "I've found that there is a higher correlation between the value of the U.S. dollar and crude oil prices than there is for any other variable. Why is that? Because supply and demand are not good predictors any more. Crude oil has become a financial instrument. Every day one billion barrels of crude are traded on the NYMEX. Every barrel in the U.S. is traded over 50 times per day. Supply and demand don't count as much anymore."

The team at investment tools provider Forex recently graphed the relationship between the dollar's value and the price of oil, using the value of the Euro versus the dollar as the other variable. In this case, as seen below, the relationship is a direct one, meaning that as the value of the Euro rises versus the dollar, the price of oil rises as well.

 

 

Source: Forex Market News

The period where the price of oil did not much react to a change in the value of the Euro versus the dollar came in 2010, when the Euro fell precipitously for a short while during the debt crisis in Greece and Ireland.


Take all this and add in a recent "risk premium" for the turmoil going in Libya and other parts of the Mideast, and presto - you get a price per barrel of oil now probably some $30.00 over what it might otherwise be based on the normal supply-demand factors.

And $30.00 per barrel has a big impact on the bottom lines of most product-based companies.

 

What do you think of the role of the value of the dollar and speculation in the price of oil? Is there something governments should be doing about it? Let us know your thoughts at the Feedback button below.


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