Oil revisited

As inflation rises, currencies fall. As the dollar falls, commodity prices rise. This is not a hard-and-fast rule, but in the absence of any drop in demand, commodity producers (such as OPEC) are fully sensitized to the trade-off between the dollar and their prices. In most instances, the producer is a government-owned entity that is largely responsible for funding the state budget. No government wants to tell its citizens that health care or education or pensions are being cut “because the dollar fell.”

Oil producers buy a fair amount of goods from Europe for euros. OPEC talks about the level of the dollar at every meeting. Oil economist Jim Williams estimates that over the last five years since the euro and dollar were roughly at parity, the price of oil has risen from about $25 to $60 in dollars, but only to $44 when oil producers convert dollars to euros.

It shows oil tracking the euro (and two curious divergences, in 2000 and the end of 2006). It shows the price of oil translated into euro terms. The blue line is the linear regression showing that oil prices in euro terms are now below the trendline. If they return to trend, the price will return to about 50 euros over the next year or two. How much is that in dollars? Well, nobody knows, but if the euro trends upward toward $1.40, which seems likely today, the price of oil will go to $70.

On the chart, the oil price in euro terms is also well under the red 200- period (“long-term”) moving average. The lifetime average price over the entire chart is the dark yellow line, about 27.60 euros. If the world has changed permanently, we can’t expect the oil price to return to the average. And the world has changed permanently, with the true opening up of China and its two-pronged demand for commodities.