Sunday, October 19, 2014

Oil continues to fall despite rises in all other assets | Sauce for the goose is not always sauce for the gander

Despite a decent rise in stocks on Friday, which coincided with a recovery in other commodity prices, oil continues to fall. Nothing, it seems, can influence anything other than a reduction in the black gold. Not geopolitical tensions in many parts of the world, not rising economic wellbeing, which should increase energy demand, not the decisions by a number of governments, most notably Germany, to ban nuclear power stations and fall back on fossil fuels and not the onset of winter in the Northern Hemisphere.

The main explanation for this state of affairs lies in the US, and to some extent in Mexico. Both of these countries are on the verge of liberalising their oil drilling policies by for the first time allowing exploration to take place on the near-offshore continental shelf, in arctic regions that were previously off-limits because of wildlife safety concerns and on Federal lands, which comprise of natural parks and other similar facilities. And then, of course there is the popularity of fracking in the US, or the use of high pressure water on a grand scale to allow the extraction of oil and gas from previously inaccessible reservoirs, mainly because of their depth.

Now the USA is projected to pass Saudi Arabia in terms of oil production, and this mainly on the strength of fracking. Thus, the ending of exploration moratoria will only add to the supply side, further weakening oil prices for some time to come.

Sauce for the goose is not always sauce for the gander

What is happening to oil prices is good for the US economy because it is so diverse. Even the fact of low fuel prices, particularly for transport, and the prospect of more reductions to come provide a very real and important psychological boost to American consumers. It is probably no accident that Consumer Confidence stateside hit its highest level in more than seven years last Friday.

In the case of countries like Canada, however, things are just a little different. Certainly, Canadians will benefit from the same low energy costs as those living south of the border. But the Canadian dollar is one of the so-called commodity currencies, so lower oil prices can be expected to involve a reduction in its value, all other things being equal, and most especially interest rates.

And as the chart above shows, the long term tendency is for the value of the Canadian to indeed fall relative to the greenback (A rise in USDCAD indicates a weakening of the Canadian dollar).

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