Investors around the world have watched, in awe, as the price of oil has fallen from the lofty level of $147 a barrel down to $64 a barrel as of this writing.
Can it go even lower in the near term? Sure. There’s been such demand destruction due to the exorbitant price at $147 that it has made people drive fewer miles in their cars (on average) all over the world.
Also, the global recession that we are experiencing right now is slowing down the production of goods which requires less energy, and thus less oil too.
However, it would not surprise me if oil bottomed somewhere in the $40 to $50, and here’s why.
Different oil exporters have different break-even points when it comes to what it takes to get their oil out of the ground, refined, and ready for use. They also need a certain level of profits from these exports to support their economies.
So let’s look at a few of these break-even points. I think you will see what I mean.
Some of the most recent extra supplies that we’ve seen come on the markets has been from Canada’s oil sands. However, there is a very expensive process that goes along with getting oil out of this area. It’s much more costly than it is in most places in the world.
However, there is an abundance of oil there. But the Canadians need a whopping $90 a barrel oil price just to break even. If oil is as it is now, it becomes an unprofitable venture, and Canadians might as well taper off production if all they are going to do is end up with a loss.
So the Canadians have a huge incentive to see the price of oil rise once again. This will not likely happen immediately, but I’m sure they were very much in favor of OPEC’s 1.5 million barrel a day cut in production this past week.
As production is cut, it gives oil the opportunity to go higher over the long haul as demand eventually increases once again. That won’t happen right away, but it is one thing they can do to get oil headed higher over time.
Brazil, as you know, discovered a whopping oil field recently. The only problem? It’s located deep in the ocean floor. Most rigs are in shallower waters, and oil there is less costly to extract.
So in Brazil they have a break-even point of $70 in order to begin to make it worth starting the process of tapping into that oil. This gives them a huge incentive to see the price of oil rise once again too.
Libya, which holds Africa’s largest reserves, is figuring their budgets next year for $45 a barrel oil in order to remain profitable. Last year they were able to work off of $60 to $65 a barrel oil. So cuts in the budget had to be made there in order to adjust to lower oil prices. Therefore, they also have a huge incentive to want to see oil prices rise once again.
Saudi Arabia is actually in the best position. They only need $30 oil as a break-even point. The UAE needs approximately $40 to $45 a barrel to break even. In comparison, Qatar needs a higher $55 a barrel to stay afloat.
Here are the countries with staggering break-even points. Iran needs $100 a barrel oil in order to break even, and Venezuela needs a whopping $120. Obviously, some serious budget adjustments will be needed in these two countries in order to adjust to prices as they are right now. But you can see why they wanted at least $2 million worth of production cuts per day.
So just realize that a lot of important oil exporters have a huge incentive to see oil’s price rise once again. That means you should not get used to these low prices because they aren’t here to stay. Oh they may last longer than both you and I think, but it’s not permanent.
What does all this have to do with currencies?
Oil has a huge effect on several currencies. If you can see what oil should eventually do, then you will know where certain currencies will likely go once oil finally makes its turn back up. So let’s explore that a bit.
Who benefits the most and who hurts the most when oil prices start to ascend once again?
The commodity exporting countries will be among the first to turn upward, in particular those that are major exporters of oil. So which are the commodity currencies? Canada (CAD), Australia (AUD), and New Zealand (NZD)
Canada, however, is the biggest oil producer among these three since Australia’s focus is on gold and copper. New Zealand has an oil field that is on line and is producing more all the time. But Canada’s oil affects about 8 percent to 9 percent of their GDP. So, among these three commodity exporting countries, Canada will be oine of the biggest beneficiaries as oil makes its eventual turn higher.
Whose economies get punished the most as oil turns higher? Two countries: the United States and Japan
Japan imports approximately 99 percent of its oil, so it is held hostage to it no matter what the price of oil is at the time. When the price is lower, they get a break. But when prices rise, they feel the pain.
Oil is priced in dollars. So when oil heads higher, it puts downward pressure on the buck and makes it more expensive.
Also, the United States is the biggest consumer of oil in the world. So we feel the pain badly. In the 1970s the United States was a net exporter of oil. But that was the end of the glory days. Since then, we’ve been a net importer of oil here in this country.
So, you will likely see the U.S. dollar struggle once again when the commodity boom starts its next leg upward, in particular when oil prices start to rise.
When you see oil’s eventual rise, look to the Canadian dollar to start its eventual ascent higher, and look for the U.S. dollar and Japan’s yen to eventually head lower.
The most affected pairs could be USD/CAD and CAD/JPY when this happens. USD/CAD will have a tendency to head lower once the higher oil prices start to finally help Canada and clamp down on the Unites States.
So an investor would look to be short this pair when this all starts to unfold.
Yet, CAD/JPY will tend to head higher at the same time, as the yen’s reign is finally over for the time being and Canada’s oil sands are profitable once again.
So, your first gauge is to see the turn upward in oil prices. Then, and only then, would you want to look for the eventual turn upward of the Canadian dollar against both the U.S. dollar and yen. Sometimes this effect doesn’t kick in immediately, so be patient and watch the charts for the eventual turn.
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