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The Biggest Threat to High Oil Prices

The biggest threat to oil prices isn’t excess supply, uneven demand or slowing global growth.

It’s the rise of the U.S. dollar – or more precisely, the fall of the euro.

You see, oil and other commodities are priced in U.S. dollars, so as the dollar strengthens, their value declines. Conversely, as the dollar loses value, the prices of commodities increase to reflect that.

The dollar has been a very weak currency over the past decade, which has helped fuel the bull run in commodities. And for a long time, it looked as though the dollar would only get weaker.

After all, the U.S. Federal Reserve has held interest rates at a record low range of 0% to 0.25% since December 2008, and it’s pledged to keep them there through 2014.

Meanwhile, U.S. debt has grown at an exorbitant rate to where it’s now more than $15.7 trillion. And Congress has yet to come up with a comprehensive plan to reduce that sizeable burden.

In fact, lawmakers actually exacerbated the problem last year by engaging in a high-stakes game of chicken with the debt ceiling. That led to the country’s first ever credit ratings downgrade.

Under normal circumstances, the U.S. dollar would be plummeting right now. But we live in extraordinary times: As it grapples with austerity measures and a full-blown depression, Greece is pondering an exit from the euro that would undermine the currency bloc.

As a result, the euro – which had been surprisingly resilient – dropped to its lowest level in four months. The euro today (Tuesday) fell as low as $1.2681 at – the lowest it’s been since January 18.

Riskier, higher-yielding currencies have been victimized by Europe’s travails, as well.

For instance, earlier this week the Australian dollar declined to less than parity with the dollar for the first time this year amid concern that Greece will leave the euro bloc.

But the dollar has only grown stronger, reaffirming its role as the world’s dominant investment safe haven.

The U.S. Dollar Index, which tracks the greenback against six major world currencies, is seeing its biggest gains since 2008.

The Index traded at 81.267 today, making that the thirteenth straight day of increases. That’s the longest winning streak the Dollar Index has recorded since August 2008, just before the last financial crisis really took off.

That’s added fuel to the recent decline in oil prices, which today slid below $93 a barrel for the first time since December. They’re now down 12% since the beginning of May.

Similarly, gold is at its lowest price in six months.

However, both of these commodities have demonstrated some resiliency. And the Greek crisis notwithstanding, their fundamental outlook is unquestionably bullish.

In fact, a new report by members of the International Monetary Fund’s internal research team says there could be a permanent doubling of oil prices in the next 10 years.

“While our model is not as pessimistic as the pure geological view that typically holds that binding resource constraints will lead world oil production on to an inexorable downward trend in the very near future, our prediction of small further increases in world oil production comes at the expense of a near doubling, permanently, of real oil prices over the coming decade,” argues the report, entitled “The Future of Oil: Geology v Technology.”

The International Energy Agency (IEA) has also warned that crude prices will remain high in 2012. The group estimates global oil demand will expand by 800,000 barrels day this year.

The IEA’s assessment of global oil market conditions is broadly in line with the views of OPEC, which said last week that oil demand had “stopped its declining trend.”

The cartel, led by Saudi Arabia, has worked diligently to keep the market flush with crude, but the effect has been negligible.

Even at a near five-month low, West Texas Intermediate crude settled yesterday at $93.84. That’s still incredibly high by historical standards, and relatively sturdy amid all of the drama in Europe – especially considering increased global demand and political disruptions in Iran could lead crude significantly higher in the near future…

It’s just a matter of clearing that one huge hurdle – a task that unfortunately is getting more and more difficult by the day.

Cheers,

 Jason Simpkins

Jason Simpkins

, Energy Editor

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