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Oil bubble: A hedge for much more than the US dollar
June 3, 2008
What's more, big oil exporters like Russia, Mexico and Opec itself are growing so fast economically that their need for energy within their own borders will limit how much they can sell abroad.
Internal oil demand in Saudi Arabia, Russia, Norway, Iran and the United Arab Emirates grew 6 per cent last year, and their exports declined 3 per cent. Mexico's oil output fell 9 per cent in the first four months of 2008. If these trends continue, global crude exports could fall by 2.5 million barrels a day by the end of 2010, adding new strains to the global oil market.
Yet it was shocking to hear Minneapolis Fed chief Gary Stern on May 28th, refuting the linkage between the US Dollar's sharp decline and soaring energy prices, and denying any responsibility for the global Oil Bubble - also known as the "Oil Shock".
"I'd be careful about mistaking correlation and causation. Just because energy prices and the Dollar seem to move together, that doesn't mean that there's causation there. If you're thinking about energy prices, bear in mind that there's been some very significant changes in the global economy that have something to do with this.
"I would point to the very rapid growth in China and India in recent years, and places like that."
Crude oil speculators on the Nymex were buying "black gold" as a hedge against the US Dollar's slide against the Euro, the world's No.2 reserve currency. And perhaps traders in London - also picking up the mantle of "crude oil vigilantes" - have been buying North Sea Brent as a hedge against the British Pound's devaluation, too.
The Bank of England engineered the British Pound's sharp devaluation against the Euro by joining the Fed's rate cutting spree last November. Over the last 8 months, it's made three quarter-point rate cuts to 5.0 per cent.
The European single currency - still paying less to cash savers, but with the European Central Bank (ECB) and its "anti inflation" rhetoric behind it - soared 17% to break above 80 pence per Euro. At the same time, North Sea Brent crude oil prices doubled to $130 per barrel.
Flipped the other way round, the British Pound buys around €1.25, down from €1.50 last summer, making European imports considerably more expensive. For Ivory Tower economists, the Euro's ascent against the British Pound and US Dollar - both of which closely tracked crude oil prices - was just a statistical coincidence.
But for crude oil speculators, the sharp devaluations of the Pound and US Dollar translated into enormous windfall profits in their brokerage accounts.
Whatever the truth of the Oil Bubble's beginning - and the part played by crude oil vigilantes in the London and New York markets - it's always good to have the basic fundamentals on your side when riding the waves of a strong bull market.
Oil production is shrinking in 54 of the world's top 60 oil producing nations, including Britain's North Sea fields - where output peaked in 1999, and has already plunged by half.
The UK began importing liquid gas for the first time in history in July 2005, and its North Sea oil reserve is dwindling at an 8.5 per cent annual rate. Indeed, the curtain might fall on North Sea Brent by 2012 if enough isn't done to maintain development and exploration, according to the UK Offshore Oil Industry.
But political pressure on the Bank of England for more rate cuts could intensify after British housing prices dropped for the eighth straight month in May, down 2 per cent from a year ago. The average selling time for UK homes has climbed to almost 10 weeks, compared to 5.8 weeks in May 2007. And a further slide in home prices could topple the UK's asset-based economy into recession, deepening losses for British banks.
Another round of BoE rate cuts could renew selling pressure on Sterling and buoy Brent crude prices, oil bubble or not. But currency devaluations do not fully account for crude oil's dramatic rise to $135 per barrel last week. "Peak Oil" theorists have an equally strong explanation, and Saudi Arabia's threat to ramp-up oil production by 2012 is sounding hollow.
Currency swings do magnify the volatility and price trends in the crude oil market, however, the same way the "Yen carry" trade magnifies swings in the global stock markets. The massive volatility in Gold Prices - a proxy for global faith in paper currencies - only adds to the pressure on central banks applied by crude oil vigilantes.
No market travels in a straight line forever, and shakeouts in the crude oil market are designed to wipe-off the speculative froth. However, a British and US economic recession would not necessarily burst the oil bubble, especially not if the net result is another sharp devaluation of the British Pound and US Dollar in the foreign exchange market, which would support high oil prices.
Image: A petrol bunk just outside an oil refinery in California. | Photograph: Justin Sullivan/Getty Images
Also read:
Why crude oil price is zooming
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