Do Oil Prices Still Power International Currency Values?

By Jameel Ahmad

Do oil prices still power currency values? The answer – which is a very definite yes – may surprise you, as it did the currency trading community in December 2014 and January 2015, when oil prices plunged on OPEC’s decision not to cut supply. The markets were caught napping, having become accustomed to oil prices gently rising and falling within the range of $90-$110 per barrel, a level to which they had risen some years earlier on supply fears. Jolted awake by the downward spiral in oil, markets around the world saw the USD and its pegged Gulf currencies rise, the Ruble fall, the Euro crumble, and the CAD tumble.

The connection between oil prices and currency values is complex, but boils down to a simple rule – oil-producing countries rely heavily on the income from energy sales; this income translates into economic power and therefore adds to or subtracts from the country’s currency’s value.

The recent oil price crash comes down to basic supply and demand rules; the market perceives an oversupply and the price drops. So the questions are; how long will the price remain relatively low, and what could trigger its rise? The answers could lie in OPEC’s decisions in the first quarter of 2015. So far, the main oil-producing countries of the UAE and Saudi Arabia seem content to let the current situation continue.

Chief Market Analyst at Forex Time, Jameel Ahmad, comments: “Such a dramatic drop in the price of oil has surprised many, however OPEC’s decision not to cut production in November just confirmed a bearish longer-term outlook for the commodity. Since November (same month as the OPEC decision), the price of Crude has tumbled from $70 to below $50, while Brent has spiralled down from around $77 to $50. In January, this decline continued to below $50. There is a complete over supply of oil production and repeated global economic concerns are elevating fears that there will be reduced demand for oil moving forward, which is inspiring further selling.

Some are still anticipating oil prices bouncing back, but it appears that there could be a long wait before any reversal. Despite the oil prices falling at what some see as an alarming rate, there is a simple supply and demand equation to be answered here and the only answer has been further weakness in the price of oil. Until the oil markets find a floor and optimism rises in the global economy, meaning there could be increased demand for oil – I can’t see any recovery on the horizon with these current economic conditions.”

However this raises the question of whether such a development means that even the powerful oil-producing nations such as the UAE and Saudi Arabia risk losing profits because the prices have dropped.

Mr. Ahmad says: “We have seen losses in the stock markets around these regions, so the dive in prices is certainly weighing on investor sentiment. Other than that, it is quite tough to predict what the economic impact for Gulf nations like the UAE and Saudi Arabia will really be. Reason being, these economies are far more diversified away from oil trade reliance than some realise and I do think this has something to do with why neither nation has appeared spooked by the decline in oil prices. Other economies such as Venezuela and Russia are very much centralised on the oil sectors, while some Gulf nations have built up domestic momentum in tourism/services industries.

The question continues to be floating around regarding whether/when OPEC will cut production and to be honest, I am unsure whether they will. The economic conditions for the industry as a whole have changed in recent years, with inventories increasing in areas outside of the OPEC group; the decision not to cut production back in November was basically seen as an unconfirmed admittance that OPEC is not in control of the price of oil as much as it used to be.

If OPEC do decide to step in and cut production, they could potentially be waiting for the price to bottom and revenues to become stretched, before possibly stepping in.

So, are we looking at another historical oil price crash? Mr. Ahmad says: “It’s shaping up that way, partly because the oil bears are smelling blood and traders are becoming increasingly aware regarding the over-powering supply and demand equation that is just inspiring further selling. OPEC’s laissez-faire attitude towards the plummet in price so far has not helped even the smallest of chances for a bounce higher.”

And finally, will the international currencies continue to see volatility in early 2015? “Yes, we can expect continued volatility on the USDRUB, and USDCAD pairs, and emerging currencies will be vulnerable to the headwinds blowing from the oil markets in February. I am also on the lookout for slightly weaker Gulf currencies, mainly because they are pegged to the USD and all current indications point towards demand for the USD increasing further in 2015. This is due to the overwhelming consensus that the US Federal Reserve will begin raising interest rates, which would pressure all currencies pegged to the USD.

Moving forward, there is going to be a great deal of interest towards how the UAE Dirham and Saudi Arabian Riyal and its retrospective economies will be impacted by the complete plummet in the price of oil and the most useful response to offer is “let’s wait and see.” Any potential strength or weakness would also be data dependent, so traders or those just interested to find out if there is any potential correlation between the fall in oil and impact on gulf nation economies should keep a look out for economic data. This could be when we find out whether the relaxed stance from OPEC Committee Members so far has been for a reason, or whether they should be more anxious than it is appearing so far” says Mr. Ahmad.

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