The rise in the oil price has slowed down. The oil price in euros is not rising at all. The weaker dollar therefore has an effect on euro investors.
Over the past few weeks, the oil price has been trading in a narrow range. Brent oil prices currently seem to be caught between USD 40 and USD 46 a barrel. At the same time, there is no lack of market dynamics. There is an upward pressure on prices comes from lower production by OPEC and its partners and the hope that the oil demand will continue to recover. In addition, the weaker dollar also plays a role. Downward pressure, on the other hand, comes from by fears that demand for oil will not recover so quickly after all. The downward pressure could play an even bigger role in the coming period as more measures are locally taken to prevent the COVID-19 virus from spreading. This has resulted in lower demand expectations. All the above drivers keep each other in balance at this point in time. As a result, the rise in oil prices has come to a standstill for the time being. After the Brent oil price reached a low of USD 15 per barrel in April, the oil price showed an impressive recovery of about 180% before the rally ran out of steam. Oil has therefore not turned out to be a bad investment over the past few months. That is, for the investors in the US. After all, the vast majority of investors in the Netherlands and Belgium invest in euros.
Dollar has weakened considerably
In the month of July, the dollar has weakened considerably. There are several reasons for this. The positive sentiment on the stocks means that there is little demand for the dollar as a safe haven currency. In addition, the aggressive monetary policy easing by the Federal Reserve has led to extra pressure on interest rates. Investors are also worried about the rapid increase in US fiscal deficit now that one support package after another is being announced. The latest one is still being discussed. Furthermore, the way in which the US COVID-19 crisis is being handled, the trade conflicts with various countries and regions and the upcoming elections are other reasons for a lower the dollar. As a result, the EUR/USD has rallied (dollar has weakened) from 1.08 in May to almost 1.19.
Commodity prices usually quote in dollars
The contracts of most commodities, including Brent and West Texas Intermediate (WTI), are traded on the exchanges in New York and London and are quoted in dollars. In addition to the commodity-specific drivers, the dollar also plays an important role in pricing. As a result of the negative correlation, the ‘natural tendency’ of a commodity denominated in dollars is to trade in the opposite direction of the dollar. Easier said, the moment the dollar weakens, the commodity prices often rise. After all, you will have to pay more dollars for a barrel of oil. A weaker dollar is therefore one of the reasons for the sharp rise in copper and gold prices. In the case of oil, however, the fear of a less strong recovery of the demand for oil is now dominating, as a result the rise in oil prices seems capped.
Possible price correction before further recovery
If we convert the Brent oil price to euros, we see this effect. While the oil price in dollars still rises marginally, this is not the case for the oil price in euros. So at this moment the weaker dollar is causing a lower return on an investment in oil for a euro investor. The rate of the dollar has weakened a lot. This could mean that some recovery could take place at some point. New strict lockdowns, and therefore downward demand adjustment, could result in lower oil prices. In addition, OPEC+ will start producing more oil and the production of (shale) oil in the US could slowly picks up again. Moreover, we think that the oil price may have risen too quickly. All this could lead to taking profit on, and thus reducing, net-long positions (investors speculating on further price rises). We are therefore expecting a temporary downward correction in Brent and WTI of around 10-15% in the coming months.
We do not expect more upward potential in oil prices until the end of the year or in 2021. Indeed, a real increase in demand for oil will require global growth to pick up again. A working vaccine against COVID-19, or at least the sight of it, seems to be an important requirement for this.
This column has also been published in the Beleggers Belangen mazagine (in Dutch).