By Nathan Boardman
A concealed connection exists between various currencies and crude oil. Price movements in a particular setting elicit a corresponding response in the alternative setting, either in support or opposition. The persistence of this correlation can be attributed to various factors, such as the allocation of resources, the equilibrium of trade (BOT), and market sentiment.
Crude oil also plays a substantial role in amplifying inflationary and deflationary forces, further enhancing these connections during periods of pronounced positive or negative trends.
Oil Prices Expressed in Dollars
Crude oil is typically priced in United States dollars (USD). Nations that purchase oil settle the payment using the United States currency. Likewise, individuals who export the product receive compensation in United States dollars. The mentioned system traces its origins to the early 1970s following the disintegration of the Bretton Woods gold standard. During this era, the petrodollar system emerged, which facilitated the ascendance of the United States dollar as the global reserve currency. Oil producers and buyers utilize the system to trade the commodity using United States currency.
Every increase and decrease in the currency’s value or the product’s cost results in an instant adjustment between the currency and various foreign exchange pairs. The correlation of these movements is lower in countries lacking sizeable crude oil reserves, such as Japan, and higher in countries possessing substantial quantities, like Canada, Russia, and Brazil.
The Formation of Oil Correlations throughout Time
Numerous countries utilized crude oil reserves during significant growth in the energy market from the mid-1990s to the mid-2000s. They took on substantial debt to develop infrastructure, enhance military activities, and launch social initiatives.
The bills were due following the economic collapse of 2008, during which certain countries opted to reduce their debt while others chose to increase it, borrowing additional funds against their reserves to rebuild confidence and direction in their struggling economies.
The increased debt burden played a significant role in maintaining elevated growth rates until the global decline in crude oil prices occurred in 2014, resulting in recessionary conditions for nations reliant on commodity markets. Several countries with abundant energy resources, including Canada, Russia, and Brazil, faced significant challenges as they grappled with the sharp decline in the value of their respective currencies – the Canadian dollar (CAD), Russian ruble (RUB), and Brazilian real (BRL).
The propagation of selling pressure extended to various commodity categories, instilling considerable concerns regarding global deflation. The correlation between impacted commodities, such as crude oil, and economic hubs lacking substantial commodity reserves, like the Eurozone, was strengthened.
Currencies in countries with substantial mining reserves but limited energy reserves, such as the Australian dollar (AUD), experienced a sharp decline, similar to the currencies of oil-rich nations.
Uncertainty in the European Union
The Eurozone experienced a deflationary scare towards the end of 2014 due to the decline in crude oil prices, which led to negative consumer price indices. The European Central Bank (ECB) faced increasing pressure in early 2015 to implement a significant monetary stimulus program to halt the deflationary trend and inject inflation into the economic framework.
Bond-buying initiation in the European rendition of quantitative easing (QE) commenced during the initial week of March 2015. Quantitative easing (QE) conducted by the European Central Bank (ECB) persisted until the middle of 2018.
The growth of the European Union was observed in 2019 and continued into 2020 until the COVID-19 pandemic, which subsequently led to a recession. In the year 2022, the increase in energy costs had an influence on the reduction of household consumption, which in turn affected an economy that was in the process of recovering.
The situation was exacerbated by the invasion of Ukraine by another country, resulting in a significant increase in oil prices and heightened apprehension regarding the energy security of Europe. With the implementation of sanctions against Russia, numerous Eurozone nations faced an uneasy geopolitical predicament due to their dependence on Russian oil and gas.
Crude Oil vs. EUR/USD
Many forex participants direct their complete focus towards the EUR/USD cross, the most widely traded and liquid currency market globally. The currency pair peaked in March 2014, merely three months before a gradual decrease in crude oil prices. This decline gained momentum in the fourth quarter, coinciding with a significant drop in crude oil prices from the high 80s to the low 50s. Selling pressure on the Euro persisted throughout March 2015, concluding precisely when the European Central Bank (ECB) implemented its monetary stimulus program.
The depreciation of the Euro persisted throughout the year 2022, ultimately plummeting to a level as meager as $1.05 for each unit of the European currency. During Q2 2022, crude prices hovered around the $100 mark.
Impact of the United States Dollar
Historically, petroleum imports have been significant for the United States, even though the country possesses proven reserves. There was a shift in that year. The production of crude oil experienced an increase, leading to the exportation of 8.51 million barrels per day by the United States. In 2021, the United States witnessed the exportation of 8.63 million barrels per day. This contributed to the United States becoming the second-largest energy producer globally, following China. The increase in activity also contributed to the application of sanctions against Russia and the growth of exports to European nations in 2022.
As the United States has experienced increased global petroleum production, the U.S. dollar has reaped the advantages of crude oil’s significant decrease for various reasons. Initially, the economic growth of the United States following the bear market exhibited remarkable strength in contrast to that of its trading counterparts, thereby ensuring the preservation of balance sheets. Furthermore, the energy sector played a substantial role in the growth of the United States’ gross domestic product (GDP); however, the nation’s remarkable economic variety mitigated its dependence on this particular sector.
Following the occurrence of the Russian incursion into Ukraine in 2022, there has been an observed increase in the value of the U.S. dollar compared to numerous global currencies. This can be attributed to the haven phenomenon and the escalation of inflation. This occurrence occurred despite the significant increase in the price of oil.
A Consequence of Excessive Dependence
It is logical to conclude that countries relying heavily on exporting crude oil have experienced more significant economic repercussions than those with a broader range of resources. A perfect example can be seen in Russia, where energy accounted for more than 65% of its exports in 2014. The percentage decreased, however, to slightly above 40% of its exports in 2021.
Following the invasion of Ukraine by Russia in 2022, severe sanctions have resulted in a further significant decline in that figure.
In 2015, a significant economic downturn occurred in Russia, as the country experienced a decline in GDP of 4.6% year-over-year (YOY) during the second quarter of that year. This recession was further exacerbated by the imposition of Western sanctions, which were a result of Russia’s involvement in Crimea. The GDP for the third quarter of 2015 experienced a decline of 2.6% year over year, followed by a further decrease of 2.7% in the fourth quarter.
Subsequently, due to the shift in crude oil prices, the Russian GDP experienced a noticeable change. The GDP growth became positive during the fourth quarter of 2016 and has been positive since then. In the year 2022, it is predicted by economists that there will be a notable contraction in the economy of Russia. This contraction is attributed to the stumble of the Ruble and the rise in inflation, which has occurred following a more extensive invasion of Ukraine.
These are the nations that possess the most fabulous crude oil production in terms of barrels per day in 2022:
- United States: 11.6 million
- Russia: 10.5 million
- Saudi Arabia: 10.2 million
- Canada: 4.7 million
- Iraq: 4.3 million
The impact of economic diversity on underlying currencies is more significant than the absolute export numbers. Regarding global rankings, Colombia held the 19th position, while the share of crude oil in the country’s overall exports amounted to 25%. The extent of this firm reliance was demonstrated through the devaluation of the Colombian peso (COP) in 2014.
What Do Currencies Have in Common with Crude Oil?
Various elements establish a connection between crude oil and currencies, resulting in a potential correlation or inverse response when there is a fluctuation in the price of either. This frequently pertains to the allocation of resources and a nation’s trade balance (the equilibrium between a country’s exports and imports). Market behaviors and sentiment and the impact of crude oil on inflation are also reflected in the correlation between the commodity and currencies.
What Exactly Is the System of the Petrodollar?
Producers and buyers utilize the petrodollar system to exchange crude oil. Petrodollars do not represent distinct forms of currency. Instead, commerce is carried out using United States currency. The system was developed during the early 1970s following the termination of the Bretton Woods gold standard. During a certain period, an agreement was made between the United States and Saudi Arabia to establish a uniform system for conducting oil transactions using the USD.
Conclusion
The correlation between crude oil and various currency pairs can be attributed to three main factors. Initially, the agreement is expressed in U.S. currency. Thus, alterations in pricing promptly affect associated currency pairs. Furthermore, a significant reliance on the exportation of crude oil exposes national economies to fluctuations in the energy markets. Again, declining crude oil prices lead to corresponding decreases in industrial commodities, thereby increasing the risk of global deflation. Consequently, currency pairs are compelled to reassess and recalibrate their interconnections.
