Starting in the second half of 2014, crude oil and currency market movements reflected diverging monetary policy, economic growth, and inflation expectations for the United States compared to the rest of the world. Gross domestic product (GDP) forecasts for countries outside of the Organization for Economic Cooperation and Development (OECD), which are responsible for most of the projected growth in liquid fuels consumption, were repeatedly revised lower last year and contributed to the downward movement in crude oil prices.
The United States, in contrast, showed robust economic and employment growth in 2014, which is forecast to continue through 2015. Given this scenario, the Federal Reserve could let interest rates rise as early as this year for the first time since the recession in 2008-09. In contrast, monetary authorities facing weaker home economies have recently acted to lower interest rates in an effort to spur economic growth.
The U.S. dollar (USD) has been appreciating relative to most other currencies, reflecting the perceived strength of the U.S. economy in relation to other OECD and non-OECD countries.
While the observed inverse relationship between crude oil prices and the value of the dollar is associated with changes in monetary policy and economic growth expectations, it also has implications for crude oil production. Oil-producing nations can be divided into two groups–those with free-floating currencies and those with a fixed exchange rate to the USD.
Countries such as Brazil, Norway, and Canada have free-floating currencies, and oil producers in these countries tend to rely on more-expensive oil production methods, such as offshore operations or bitumen extraction, to replace natural declines in existing production. Because the USD strengthened broadly compared with most other currencies in the past eight months, the decline of North Sea Brent crude oil priced in other currencies is less than the decline in USD.
From August 1, 2014 to February 18, 2015, Brent prices fell 42% in USD (Figure 1). However, when measured in other currencies, the price of Brent fell less, down only 27%, 31%, and 34% in the Brazilian real, Norwegian kroner, and Canadian dollar, respectively.
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International oil producers experience some benefit from lower exchange rates with the USD. While their oil revenues are denominated in USD, costs associated with oil production, such as wages, local transportation, and taxes that are denominated in local (weaker) currency are lower.
Other countries, including Saudi Arabia and some other key Middle East producers, keep a fixed exchange rate to the USD. Crude oil exports make up the overwhelming portion of these countries’ total exports. In 2013, for example, total petroleum exports accounted for 85% of total Saudi export revenues, meaning most of Saudi Arabia’s export revenues were USD-denominated.
While Saudi Arabia and other countries with currencies pegged to the USD see the same price movements in both USD and local currency terms, they may realize significant benefits from movements in other currencies. The government of Saudi Arabia is responsible for most of the economic activity within the country, and, in recent years, imports have accounted for a large and growing portion of government spending.
From 2011 to 2013, total imports as a percentage of total government expenditures rose from 46% to 62%, according to the Saudi Arabia Ministry of Finance. Of the imports Saudi Arabia purchased in 2013, 65% came from countries that do not maintain a fixed exchange rate or use the USD, similar to levels in 2012 (Figure 2).
Because of Saudi Arabia’s currency peg to the USD, a stronger USD will put downward pressure on import costs, easing some of the impact of lower crude oil revenues.
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