How does oil drive USD, CAD, AUD exchange rates?
‘Technology fuels economy, unfortunately in today’s world it’s fuel that drags economy.’ ― Yatin Patel.
It is unquestionable that our love for the viscous black liquid has brought civilisations to boom, bust and everywhere in-between, but how does it affect the exchange rates of currencies like the US Dollar and Canadian Dollar? Massively is the answer.
In 2014, the three largest oil producing nations are Russia, Saudi Arabia and the United States. Let’s say that all of a sudden the price of oil falls due to excess supply over demand (something which occurs far more than you may realise). The lower prices cause the Russian Ruble, Saudi Arabian Riyal and US Dollar to depreciate as fewer exports are required and are exported at a cheaper rate. But it doesn’t stop there…now the three biggest oil importers (China, United States and India) benefit from cheaper prices and, thus, the Chinese Yuan, US Dollar and Indian Rupee appreciate.
Simply put; many of the most important currency trading pairs rise and fall on the price of a barrel of oil. A good example of this would be the US Dollar to Indian Rupee (USD/INR) exchange rate. Let’s say the price of oil has dropped because Russia has produced an excess of oil and demand from China has softened. In this scenario the USD/INR exchange rate would depreciate because oil is cheaper to import for India, with less demand for American supplies.
How does natural gas affect JPY, RUB, EUR exchange rates?
It is fair to say that natural gas is a commodity less sought after than oil, but is still in high enough demand to effect changes in an economy and, therefore, in a currency. It is also a powerful enough energy source to replace oil although, akin to crude, it is far from sustainable.
The three largest natural gas exporting countries in 2014 are Russia, the Arab League and Canada. Therefore the Russian Ruble, various Arab League currencies and the Canadian Dollar would appreciate if demand exceeded supply, driving prices up. If this was the case, however, the three largest natural gas importers (European Union, Germany and Japan) would be economically damaged by more expensive imports. This, therefore, would cause the Euro and the Japanese Yen to depreciate.
A good example of how natural gas affects currencies would be the EUR/CAD exchange rate. If the price of natural gas were to rise because supply in Russia couldn’t keep up with German demand; the EUR/CAD exchange rate would soften. This is because there would be higher demand for Canadian natural gas, and therefore the Canadian Dollar, but Europe would be spending more on imports which, in turn, would drive down the value of the common currency.
One fuel to rule them all?
A significant new source of methane has been discovered which could turn the commodities market on its head.
An article in the science section of The Economist explains; ‘The overwhelming majority of the methane extracted commercially and 90% of what is in the air is biotic—that is to say, it comes from the decomposition of the stuff of life. However, natural gas can also form abiotically, as a result of chemical reactions in a kind of volcanic rock called peridotite. Add to such rock the heat and pressures of depth, throw in a splash of water, and eventually out comes methane.’
The generally accepted view of abiotic natural gas is that it is rare and therefore not a viable energy source. However, new sources seem to be discovered at an exceptional rate, as The Economist goes on to explain; ‘ Well-understood as the phenomenon is, however, such ‘seeps’ of abiotic methane were until recently believed to be an exceptionally rare thing […]That view is now changing. In 2013 and so far in 2014, a further five abiotic gas seeps have been reported in Portugal, Greece, Italy, Japan and another in Turkey. The man behind many of these finds is Giuseppe Etiope of the Italian National Institute of Geophysics and Volcanology, in Rome. Together with colleagues in Canada and Spain, Dr Etiope has discovered two more abiotic seeps that the team will report in December, at the annual meeting of the American Geophysical Union.’
How would a new source of natural gas affect foreign exchange?
If enough abiotic gas sights are discovered and produce enough methane, there is no reason the new source could replace both oil and biotic natural gas. But let’s imagine what that would do for exchange rates. Suddenly the world’s largest oil producers are no longer the leaders of energy exportation. In addition, the world’s foremost exporters of biotic natural gas now see their exports replaced by abiotic sources.
So in the event of the scenario mentioned above, the Russian Ruble, Saudi Arabian Riyal and US Dollar would depreciate on the lack of demand for oil. Similarly, the Russian Ruble, various Arab League currencies and the Canadian Dollar would soften on lack of demand for biotic natural gas.
However, suddenly Portugal, Greece, Italy, Japan and Turkey become the economic powerhouses on energy exportation. The Euro, Turkish Lira and Japanese Yen appreciate.
A change to the Euro to Russian Ruble (EUR/RUB) exchange rate is a good example of how abiotic natural gas would affect the currency market. If oil production declined under the weight of a new source of natural gas the EUR/RUB would appreciate. This is because the new source is found in many European countries, whereas Russia’s oil producing demand would be reduced to potentially nothing.
A long way off…
It is important to mention that these scenarios are just that, and this new source may come to nothing. Even if it does transpire that abiotic natural gas is the energy of the future, it will be some years before that change can be implemented.
To conclude, The Economist stated; ‘As a newly appreciated potential source of gas, it will take some time to understand just how many abiotic seeps there are, and how much methane each might produce. The general view of hydrocarbons such as oil and gas is one of dwindling reserves. But there is still some exploring to be done.’
