Tuesday, April 01, 2008

Dynamics of the Energy Market Force an International Perspective

Oil prices continue to fluctuate wildly around the $100/bbl mark, but an interesting dynamic has developed. Prices no longer revolve simply around the supply/demand curves. The falling dollar has largely turned oil pricing into a function of the dollar.

Oil has become a hedge against the falling dollar. And, the weak dollar means that prices for oil in most economies around the world have seen significantly smaller increases than a simple quote in dollars would suggest.

Of course, the law of supply/demand has not been repealed, it has just been complicated by economic conditions. Demand is up, not because of usage, but as a result of the hedge. And, in many other countries, the offset of currency fluctuations has reduced the effective price, and thereby increased the demand.

All the above will make oil prices even less predictable and more volatile. Recently the hedge demand has driven big increases in price, but a reversal of this demand could cause a big drop. And so, enter the effect of the Fed into the oil market. The news today is increased control of banks by the Fed, but their effect on the oil market could dwarf their banking responsibility.

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