Dollar Valuation and the Price of Oil

By April 3, 2008Energy

The return of the dollar to its more historic levels vis a vis other world currencies (as represented by the Euro, mostly) has made the U.S. manufacturing sector more competitive in the global marketplace. Exports are up, up, up.

The Michigan papers provided a good case study today, “Weak dollar benefiting Michigan manufacturers, exporters.”

But it’s not all skittles and beer, and we’re seeing more pundits and economists (in that order) calling for a return to the “strong dollar” policy. It’s a big issue for Larry Kudlow, for example.

A low-value dollar certainly makes oil more expensive, a point that Peter Robinson, Vice Chairman of Chevron, made in his prepared testimony this week to the House Select Committee on Energy Independence and Global Warming.

This new reality and the impact on oil prices are compounded by the weakening of the U.S. dollar. The higher oil price is in part a market adjustment that reflects the weakening purchasing power of oil exporting countries that sell their oil in U.S. dollars but buy goods with stronger currencies such as the euro. Additionally, the weak dollar—and concern by stock investors over the subprime issue and its impact on the stock market—has contributed to a flight to commodities by investors seeking better returns (See Appendix chart #7). Oil has gone up along with many other commodities such as gold, corn, copper and even coal. While oil has reached record highs this year, a Washington Post article on March 20 reminds us that the tightening global energy-supply demand balance also has affected coal, which has increased in price by approximately 9 percent since the beginning of the year.

This has created a somewhat unusual situation that was observed by one economist speaking to the Wall Street Journal: “Crude futures prices,” he said, “have decoupled from the forces controlling the underlying physical flows of the commodity.” Or, more simply put, the weak dollar keeps prices high, even though the market has responded both with more supply to meet demand and, in some sectors, a lowering of demand. In fact, recent figures from EIA suggest that demand in the United States has moderated in response to the current high prices. That prices still remain high underscores the fact that many factors are in play and there are no short-term fixes to today’s price levels.

Robinson responded further to the issue in a bloggers’ conference call that the American Petroleum Institute organized Tuesday (transcript here). Excerpt:

[If] you look at the relationship between the dollar – if you go back three or four years and you know, where oil was $30 or $35 or something like and we’re sitting in Europe, we’re sitting here, to us it looks like the price of oil has tripled. To the Europeans, it looks like it’s doubled. And in addition to that, you know, if you’re in three or four years ago, in the U.K., for example, paying $6 or $7 a gallon for your gasoline, the fact that the crude oil component of it is doubled really is a relatively small increase in your gasoline price, compared with for us, where it looks like our oil has tripled and we had low prices because we have low taxes, it looks like a huge increase here.

Come to think of it, there does seem to be a lot less screaming and table-pounding in Europe about oil gas and diesel prices than there is here in the United States.

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