Home > Energy Market Articles > The USD strength and oil price – an incidental relation

The USD strength and oil price – an incidental relation

Historical analyses between the US strength and the oil price have shown them to be negatively correlated at times.  A plausible explanation is that the oil prices are more affordable when the USD weakens prompting oil importing countries to import more and increasing demand.  In fact, this has been frequently cited in news as such.

The reasoning however is flawed. Whilst there have been episodes in the past they correlate negatively, these are more due to the investment community buying the rumour than the fact. Firstly, comparatively the major oil importing countries in the world like China and Japan spends only a fraction of their GDP on oil. Together they import less than 10 million of oil a day, or about USD 300 b a year. This compares little to their more than 10t in annual GDP.  Further, research has shown that global oil demand is inelastic to prices in the short term. This is true even in the long term. Whilst there has been talk that the recession in 2008/09 was caused by the prior spike in oil prices, this is debatable and better attributable to the massive housing debt overhang in the financial sector.

Rather the relation between the oil price and USD strength is incidental at best, driven more by financial factors than economic factors. Financial factors include quantitative easing and investment flows. Even these factors have proved less important with QE2 and increased commodity funds flows not increasing prices beyond $85 recently. This incidentally is due to the overhang of oil stocks in the developed countries making the oil price less elastic.

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