Month: June 2017

How Oil Prices Influence Currency Fluctation

In the Forex market, the values of currencies move up and down as a result of many factors, including — but not limited to — supply and demand, interest rates, economic growth and political conditions. Because of this, the more dependent a country is on a large domestic industry like oil, the stronger the correlation will be between a national currency and its industry’s commodity prices.

In general, there is no uniform rule for determining what commodities a given currency will be correlated with and how strong that correlation will be. However, some currencies provide good examples of commodity-Forex relationships — and oil, in particular is one of the most powerful commodities when it comes to influencing the value of currencies associate with its production.

Here are 3 tips about oil prices and their effect on Forex trading that all traders need to know:

Oil Prices Affect Currency Values

For an example of a currency that is directly connected to the price of oil, consider the Canadian dollar. When the price of oil goes up — usually because of worldwide demand and the limitations put on oil production by OPEC nations —  the Canadian dollar tends to become worth more when based against other currencies. Canada is a net oil exporter, so when oil prices are high, Canada often receives greater profits from its exports, which gives the CAD a boost on the Forex market.  Therefore, when trading pairs involving CAD (such as USD/CAD or CAD/USD, it is wise to have an understanding of the current forces working on oil prices.

Recent times have seen oil prices come down to the lowest they have been in years —  under $50 a barrel, which has had a huge impact on countries maintaining large oil resources, including Norway and, of course, Canada.  A recent headline on OilPrice.com says it clearly, “Conflicting News Keeps Oil Prices Down,” and wise Forex investors always keep an eye on major nation commodities before committing to their trades.  

One other quick example to explain the connection between commodities and currency value:  The Australian dollar (AUD) is positively correlated with gold. Because Australia is one of the world’s biggest gold producers, its dollar tends to move in unison with price changes in gold bullion. This means that when world gold prices rise significantly, the Australian dollar will also be expected to appreciate against other major currencies.

Oil Prices Affect Other Aspects of the Economy 

Along with the direct result changes in oil prices have on a country’s currency value, it is important to take into consideration the other subsequent effects that happen when oil prices rise or fall.  Before the lowering of oil prices, cities in Canada such as Calgary had huge construction and housing booms, as workers poured into the city to take oil-related jobs and make money from the growing business. However, the change in oil prices from 2014 to 2015 had devastating consequences for Calgary’s housing market, as seen in this article from the time.

Similar events are currently happening in Norway, and while USD/NOK is perhaps not the most traded pair, investors who are interested in trading the Krone would be advised to stay on top of articles like this, which show that recently housing prices in Norway have fallen more than expected, thanks to the price of oil driving down the economy.

Understand Why the Price of Oil Moves 

If you are trading currencies that are affected by oil prices, it would be a good move to have an understanding about the forces that drive the price both up and down. Crude oil prices move largely because of the perceptions of supply and demand affected by worldwide output, as well as the overall global economic prosperity. In the commodities market, an oversupply of oil and shrinking demand encourages commodities traders to sell crude oil markets to lower prices. Rising demand (and declining production) encourage traders to bid crude oil to higher prices.

Within the past decade, we have seen everything from the surge of crude oil to $145.81 per barrel in April 2008 to downtrends in August 2015 bringing the price down to $37.75 per barrel.

Where oil goes, currency values will follow, and smart Forex traders will always monitor oil prices to help them determine the trends that could follow immediately from how the world prices its oil.

3 Critical Factors that Determine Oil Prices

 

3 Critical Factors that Determine Oil Prices

Forex traders have learned that oil prices have a profound effect on the values of currencies, with rising oil prices helping certain countries (such as Canada and its CAD) and falling oil prices leading to these currencies losing value.  Smart Forex traders understand that keeping an eye on oil prices can be helpful to spot trends in the market as early as possible, and to that end, they watch oil prices for changes that could have an effect on the currencies they trade.

To better understand how these oil prices are determined in the first place, this article will take a look at the three main factors considered by commodities traders when they develop the bids that create oil prices:

3 Factors Commodities Traders Use To Set Oil Prices

#1 – Current supply in terms of output. For many years the current supply of world oil was controlled by the Organization of the Petroleum Exporting Countries (aka “OPEC”) and its production quotas. However, when U.S. shale oil production doubled between 2011 and 2014, an oil glut was created, and the price of oil fell as low as $45/barrel in 2014.

Prices fell again in December 2015 to a low of $36.87 a barrel, and typically OPEC would have cut supply to keep oil at OPEC’s target of $70 a barrel, but it instead allowed prices to fall, knowing that money would still be made as long as oil remained above $20 a barrel.

Unfortunately for the new shale oil producers, they required a price of at least $40-$50 a barrel to stay financially solvent, and OPEC saw this as a way to remove their new shale oil competitors.

OPEC bet correctly that the shale oil producers would go out of business, allowing OPEC to keep its dominant market share, which began to happen in 2016.

#2 –  Access to Future Oil Supply. Along with the current oil supply, investors in oil keep an eye on oil reserves, which include what’s available in U.S. refineries as well as in the Strategic Petroleum Reserves, an emergency fuel storage of petroleum maintained underground in Louisiana and Texas by the United States Department of Energy. (This is the largest emergency supply in the world, with the capacity to hold up to 727 million barrels.)

These reserves can be accessed very easily, increasing oil supply if prices get too high. Saudi Arabia can also tap into its large reserve capacity.  For investors, the existence of these oil reserves serves as a balance to low demand and subsequent rising prices.

#3 –  Demand for Oil. Ultimately, and unsurprisingly, the world’s demand for oil — particularly from the United States — is a huge factor that influences prices. Each month, the Energy Information Agency provides estimates for the demand for oil. In general, demand usually rises during the summer vacation driving season beginning with Memorial Day, and to predict this summer-time demand, forecasts for travel from AAA (the American Automobile Association) are used to determine potential gasoline use. During the winter, the Energy Information Agency uses weather forecasts to determine the potential use of home heating oil.

One other factor that is impossible to predict, but absolutely has an impact on oil prices, are unforeseen crises in oil-producing countries. These potential world crises often dramatically increase prices, especially when traders worry that a crisis will limit the supply of oil.

One example of a crisis like this happened in January 2012 after inspectors found proof that Iran was closer to building nuclear weapons capabilities, after which the United States and the European Union began financial sanctions.

Iran threatened to close the Straits of Hormuz, and the U.S. responded with a promise to reopen the Strait with military force if necessary. The possibility of an Israeli strike was also a concern.

As a result, oil prices bounced around $95-$100 a barrel from November through January, anc then by February, oil broke above $100 a barrel and stayed there. You probably remember that gas prices in the U.S. also went to $3.50 a gallon, with forecasts saying that gas would be at least $4.00 a gallon through the summer driving season.

Along with these factors, oil traders also watch out for natural disasters and other events that could prevent the production of oil. As a Forex trader, you should take the time to learn more about oil prices and how they are set so you may be able to profit from trends that result from this important commodity.