June 06, 2008
Oil Prices in Other Currencies
Some of the explanations for the dollar jump rely upon the perceived weakness in the dollar's value (and hence, by extension, Fed policy). Does this make sense?
As I've remarked before , there is likely two way causality between the dollar's value and the price of oil denominated in dollars. One way of taking out some of the numeraire issue is to see how a price of a barrel of oil would be, expressed in other currencies. In the figure below, I compare the dollar price against that in euros, and against that in the Special Drawing Rights (SDR).
Figure 1: Price ber barrel of oil (WTI), in USD (blue), in SDR (red), and in EUR (green). Squares indicate values for June 6. NBER defined recession dates shaded gray. Sources: St. Louis Fed FREDII; IMF International Financial Statistics; Pacific Exchange Services; and author's calculations.
The weights for the USD, EUR, JPY and GBP in the SDR are 0.44, 0.34, 0.11 and 0.11, respectively.
What the figure highlights is that while USD weakness is associated with higher dollar prices for oil, upward trends in all prices are evident. The wedge between the dollar increase and the SDR increase since January 2008 to 6/6 is only 2.8% (in log terms; 4.2% in level terms). It's a bit bigger for the dollar/euro comparison, at 6.7% (in log terms; 9.6% in level terms)
So the dollar's exchange rate "matters" (keeping in mind two-way causality), but for the bulk of the movement in oil prices, look here.
Posted by Menzie Chinn at June 6, 2008 08:38 PMdigg this | reddit
I was wondering if the soverign wealth funds could be doing this to push up the price of oil. If they started buying oil futures through anonymous sources then it would look like there was more demand or that someone knew prices were going to rise. It is hard for them to lose because they can just supply the oil anyway, and if it drives up the price then they can use more money to speculate the price will go up more.
Posted by: RCH at June 6, 2008 08:55 PM
I wonder if desaggregating oil into heavy Iranian oil, light Brent oil, etc. would generate a more precise picture. Iran cannot sell its heavy oil and has to rent tankers to store them.
Posted by: jaim at June 7, 2008 09:07 AM
RCH, it wouldn't have to be sovereign wealth funds. Because there is only 7% margin required for oil futures contracts, it's possible to leverage up in the same way that housing was levered up.
But it's also true, as you suggest, that unless the speculator has the power to produce the oil, it's risky.
Posted by: Charles at June 7, 2008 09:44 AM
It would be interesting if you would add gold as a 'currency' to your graph as it is still the ultimate form of payment. Gold's rise indicates a rise in inflation expectations and we can agree government statistics have been underreporting price inflation, but gold's move has revealed the underlying monetary inflation that has occurred and it is not limited to the dollar - all currencies are guilty of increasing their money supply in the past 7-8 years. Most recently in 2007, world monetary inflation for all currencies was running at 15%.
Consider that gold began 2000 at $290.25 (www.kitco.com - charts and data) and finished Friday in NY electronic trade at $902.20. It took 1/10 (0.10 oz) of gold to buy a barrel of oil in 2000, and today it only takes about 1/7 (0.15 oz) of gold, so on your chart, the price of oil/bbl in gold would only come in at about $43/bbl. If gold strengthens as the reserve currency, this gap will only diminish further showing little or no increase in the price of oil in terms of gold.
Posted by: Conrad at June 7, 2008 09:58 AM
"I was wondering if the soverign wealth funds could be doing this to push up the price of oil. If they started buying oil futures through anonymous sources then it would look like there was more demand or that someone knew prices were going to rise. It is hard for them to lose because they can just supply the oil anyway, and if it drives up the price then they can use more money to speculate the price will go up more."
You know that's been one of the theories that I've had. In a sense, because the Fed is throwing money from helicopters, and the Congress can't balance it's checkbook, OPEC is left in a bind. Already, their trillions in reserve have been obliterated and yet they can't reduce supply. As you've pointed out, there's no down-side risk to their future other the cost of the contract. Furthermore, since it's a cartel, they know that no one will increase the supply to flood the market. Ordinarily, a speculative bubble bursts because the potential buyers can't justify the price. But since the SWFs control the risk, the bubble can go to infinity.
Posted by: tai at June 7, 2008 11:12 AM
rch: The sovereign wealth funds of the petro-states, e.g., Norway, are mandated to diversify the wealth not further concentrate the wealth in the same sector. Running an economy on mostly resource extraction can have all kinds of negative consequences that are referred to in the policy literature as the Resource Curse. These Sovereign Wealth funds are meant to mitigate some of those negative impacts and stabilize the flow of public services into the future.
I would be extremely surprised if sovereign wealth funds are heavy buyers of oil futures. From a risk management perspective, it makes no sense. Even if they were, they face the same problem everybody else does of taking and holding oil deliveries as more than amply argued by James Hamilton in his oil price paper.
tai: The fed is NOT "throwing money from helicopters". At least not this time. It would have to buy a lot of US federal debt to fit the helicopter analogy. If I understand correctly, the Bernanke fed is doing its best to keep the monetary base stable (see previous econbrowser blog posts).
Posted by: E. Poole at June 7, 2008 04:17 PM
Perhaps another approach to high oil prices is the complete and utter failure of the U.S. Congress to approve new drilling policies and new oil refineres.
Words for thoughts and concerns.
Posted by: mc at June 8, 2008 03:03 AM
It looks like dollar and euro are following a similar trend, but it is the exchange rate that is killing us. In terms of gas prices at the pump, one can make the case that denominated in euros, gas prices have not changed significantly since 2005, but in dollars it has increased substantially. Of course there is a time lag between gas prices and oil prices, so the euro denominated gas should also start going up.
Posted by: sivere at June 8, 2008 09:52 AM
Menzie, thanks for this. You wrote: One way of taking out some of the numeraire issue is to see how a price of a barrel of oil would be, expressed in other currencies. and while this is true your graph demonstrates that there is actually world wide inflation with the US$ inflating faster than other currencies. Because inflation does not impact commodities equally nor does it impact factors at the same time as finished goods inflation in any currency creates economic problems in those countries experiencing inflation. The fact that the US$ is inflating faster just injects more complexity into the calculation, because the US can use this lag in inflation to actually wage a monetary war against other countries. This would not be possible if currencies were not floating.
Countries (note the rhetoric between the US and China) with floating currencies are constantly trying to tweek exchange rates to gain an advantage, but the worst consequence of this is it breeds mistrust in the world economic system. Oil is quoted in dollars but even the major oil producers question the veracity of the US monetary authorities to maintain an honest currency.
Posted by: DickF at June 9, 2008 06:11 AM