the impact of dollar devaluation on world oil industry: do...

A. F. Alhajji. July 2004 1

The Impact of Dollar Devaluation on World Oil Industry: Do Exchange Rates Matter?

A. F. Alhajji, Ph.D.Associate ProfessorCollege of Business AdministrationOhio Northern universityAda, Oh, 45810


OutlineIntroductionThe Impact of Exchange Rates on Supply

Exchange Rates and Drilling ActivitiesExchange Rates and ProductionExchange Rates and ExportsExchange Rates and Purchasing PowerExchange Rates and Inflation

The Impact of Exchange Rates on DemandThe direct impactThe indirect impact

Empirical EvidenceConclusions


FactsCrude Oil is priced in US dollars while products are priced in local currencies.Oil revenues for countries and most oil companies are in US dollars.International oil companies operate around the world and use different currencies.Producing countries trade is denominated in US dollars and other world currencies.Producing countries have different trade partners.


ObservationsOil Prices are high only in dollars but they are relatively low in other currencies, especially the Euro and the yen.See the four figures below


Oil Prices in Dollar and Euro

8

13

18

23

28

33

38

43

1/4/

1999

4/4/

1999

7/4/

1999

10/4

/199

9

1/4/

2000

4/4/

2000

7/4/

2000

10/4

/200

0

1/4/

2001

4/4/

2001

7/4/

2001

10/4

/200

1

1/4/

2002

4/4/

2002

7/4/

2002

10/4

/200

2

1/4/

2003

4/4/

2003

7/4/

2003

10/4

/200

3

1/4/

2004

4/4/

2004

WTI ($) Brent (€)$&€/b


Oil Prices Dollar and Yen

0

5

10

15

20

25

30

35

40

1973

-10-

0119

74-1

0-01

1975

-10-

0119

76-1

0-01

1977

-10-

0119

78-1

0-01

1979

-10-

0119

80-1

0-01

1981

-10-

0119

82-1

0-01

1983

-10-

0119

84-1

0-01

1985

-10-

0119

86-1

0-01

1987

-10-

0119

88-1

0-01

1989

-10-

0119

90-1

0-01

1991

-10-

0119

92-1

0-01

1993

-10-

0119

94-1

0-01

1995

-10-

0119

96-1

0-01

1997

-10-

0119

98-1

0-01

1999

-10-

0120

00-1

0-01

2001

-10-

0120

02-1

0-01

2003

-10-

01

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000

$ Oil Price ¥ Oil Price$/b ¥/b


Oil Prices in Dollar and DM

0

10

20

30

40

50

60

70

80

90

100

Oct

-73

Oct

-74

Oct

-75

Oct

-76

Oct

-77

Oct

-78

Oct

-79

Oct

-80

Oct

-81

Oct

-82

Oct

-83

Oct

-84

Oct

-85

Oct

-86

Oct

-87

Oct

-88

Oct

-89

Oct

-90

Oct

-91

Oct

-92

Oct

-93

Oct

-94

Oct

-95

Oct

-96

Oct

-97

Oct

-98

Oct

-99

Oct

-00

Oct

-01

Oct

-02

Oct

-03

$ Oil Price DM Oil Price


Oil Prices in Dollar and Sterling

0

5

10

15

20

25

30

35

40

Oct

-73

Oct

-74

Oct

-75

Oct

-76

Oct

-77

Oct

-78

Oct

-79

Oct

-80

Oct

-81

Oct

-82

Oct

-83

Oct

-84

Oct

-85

Oct

-86

Oct

-87

Oct

-88

Oct

-89

Oct

-90

Oct

-91

Oct

-92

Oct

-93

Oct

-94

Oct

-95

Oct

-96

Oct

-97

Oct

-98

Oct

-99

Oct

-00

Oct

-01

Oct

-02

Oct

-03

$ Oil Price £ Oil Price$/£/b


Results

Dollar devaluation reduces oil supply and increases oil demand.Dollar devaluation reduces drilling activties in some areas such as the North Sea.Dollar devaluation reduces drilling activities in the oil producing countries. It reduces their purchasing power and causes inflation.Dollar devaluation increases oil demand in Europe and JapanDollar devaluation increases oil demand in the US as US tourists spend their vacations in the US instead of Europe.


Observations on Drilling ActivitiesDrilling activities are highly correlated with oil pricesThere is a lag when prices increase. No lag when prices decrease.Changes in the world rig count are misleading. They follow changes in US.This pattern does not hold in recent months. Is it because of dollar devaluation?


Observations on Drilling ActivitiesDrilling activities in the Middle East and Latin America are highly correlated with oil prices in US dollarsDrilling activities in Europe are positively correlated with oil prices in Euro and negatively correlated with oil prices in US dollars. As prices in Euro decrease (lower dollar), rig count decreases. As the dollar goes down, rig count goes downSee the following six figures.


Oil Prices and Rig Count

500

1500

2500

3500

4500

5500

6500

1975

Jan

uary

1976

Jan

uary

1977

Jan

uary

1978

Jan

uary

1979

Jan

uary

1980

Jan

uary

1981

Jan

uary

1982

Jan

uary

1983

Jan

uary

1984

Jan

uary

1985

Jan

uary

1986

Jan

uary

1987

Jan

uary

1988

Jan

uary

1989

Jan

uary

1990

Jan

uary

1991

Jan

uary

1992

Jan

uary

1993

Jan

uary

1994

Jan

uary

1995

Jan

uary

1996

Jan

uary

1997

Jan

uary

1998

Jan

uary

1999

Jan

uary

2000

Jan

uary

2001

Jan

uary

2002

Jan

uary

2003

Jan

uary

2004

Jan

uary

0

5

10

15

20

25

30

35

40

U.S. World Oil Price

Rigs $/B

Price


Oil Prices ($) and Rig Count (Latin America)

0

100

200

300

400

500

600

1975

Jan

uary

1976

Jan

uary

1977

Jan

uary

1978

Jan

uary

1979

Jan

uary

1980

Jan

uary

1981

Jan

uary

1982

Jan

uary

1983

Jan

uary

1984

Jan

uary

1985

Jan

uary

1986

Jan

uary

1987

Jan

uary

1988

Jan

uary

1989

Jan

uary

1990

Jan

uary

1991

Jan

uary

1992

Jan

uary

1993

Jan

uary

1994

Jan

uary

1995

Jan

uary

1996

Jan

uary

1997

Jan

uary

1998

Jan

uary

1999

Jan

uary

2000

Jan

uary

2001

Jan

uary

2002

Jan

uary

2003

Jan

uary

2004

Jan

uary

0

5

10

15

20

25

30

35

40

Latin America Oil Price$/bRigs


Oil Prices and Rig Count(Middle East)

0

50

100

150

200

250

300

1975

Jan

uary

1976

Jan

uary

1977

Jan

uary

1978

Jan

uary

1979

Jan

uary

1980

Jan

uary

1981

Jan

uary

1982

Jan

uary

1983

Jan

uary

1984

Jan

uary

1985

Jan

uary

1986

Jan

uary

1987

Jan

uary

1988

Jan

uary

1989

Jan

uary

1990

Jan

uary

1991

Jan

uary

1992

Jan

uary

1993

Jan

uary

1994

Jan

uary

1995

Jan

uary

1996

Jan

uary

1997

Jan

uary

1998

Jan

uary

1999

Jan

uary

2000

Jan

uary

2001

Jan

uary

2002

Jan

uary

2003

Jan

uary

2004

Jan

uary

0

5

10

15

20

25

30

35

40

M East Oil PriceRigs $


Rig Count: World-US, US, Vs. Oil Prices

0

500

1000

1500

2000

2500

3000

3500

4000

4500

5000

1975

Jan

uary

1976

Jan

uary

1977

Jan

uary

1978

Jan

uary

1979

Jan

uary

1980

Jan

uary

1981

Jan

uary

1982

Jan

uary

1983

Jan

uary

1984

Jan

uary

1985

Jan

uary

1986

Jan

uary

1987

Jan

uary

1988

Jan

uary

1989

Jan

uary

1990

Jan

uary

1991

Jan

uary

1992

Jan

uary

1993

Jan

uary

1994

Jan

uary

1995

Jan

uary

1996

Jan

uary

1997

Jan

uary

1998

Jan

uary

1999

Jan

uary

2000

Jan

uary

2001

Jan

uary

2002

Jan

uary

2003

Jan

uary

2004

Jan

uary

0

5

10

15

20

25

30

35

40

World-US U.S. Oil Price

Rigs $/b

Price


Oil Prices ($) Vs Rig Count in Europe

0

50

100

150

200

250

300

1975

Jan

uary

1976

Jan

uary

1977

Jan

uary

1978

Jan

uary

1979

Jan

uary

1980

Jan

uary

1981

Jan

uary

1982

Jan

uary

1983

Jan

uary

1984

Jan

uary

1985

Jan

uary

1986

Jan

uary

1987

Jan

uary

1988

Jan

uary

1989

Jan

uary

1990

Jan

uary

1991

Jan

uary

1992

Jan

uary

1993

Jan

uary

1994

Jan

uary

1995

Jan

uary

1996

Jan

uary

1997

Jan

uary

1998

Jan

uary

1999

Jan

uary

2000

Jan

uary

2001

Jan

uary

2002

Jan

uary

2003

Jan

uary

2004

Jan

uary

0

5

10

15

20

25

30

35

40

Europe Rig Count Oil PriceRigs $/B


Oil Prices (£) Vs. # of Rigs in Europe

0

50

100

150

200

250

300

1975

Jan

uary

1976

Jan

uary

1977

Jan

uary

1978

Jan

uary

1979

Jan

uary

1980

Jan

uary

1981

Jan

uary

1982

Jan

uary

1983

Jan

uary

1984

Jan

uary

1985

Jan

uary

1986

Jan

uary

1987

Jan

uary

1988

Jan

uary

1989

Jan

uary

1990

Jan

uary

1991

Jan

uary

1992

Jan

uary

1993

Jan

uary

1994

Jan

uary

1995

Jan

uary

1996

Jan

uary

1997

Jan

uary

1998

Jan

uary

1999

Jan

uary

2000

Jan

uary

2001

Jan

uary

2002

Jan

uary

2003

Jan

uary

2004

Jan

uary

0

5

10

15

20

25

30

Europe Rig Count Oil Price (£)Rigs £/b


Oil Consumption in the UKDepreciation of the dollar increased consumption in recent months. Consumption declined sharply in the fourth quarter of 2000 when the dollar appreciated relative to the Sterling and the Euro.Dollar devaluation has little impact on other European countries because of high taxes on petroleum products. See the following Figure.


Oil Prices and Petroleum Consumption in the UK

0.00

5.00

10.00

15.00

20.00

25.00

30.00

35.00

40.00

1999 January 2000 January 2001 January 2002 January 2003 January 2004 January1400.00

1450.00

1500.00

1550.00

1600.00

1650.00

1700.00

1750.00

1800.00

1850.00

1900.00

1950.00

WTI ($) Brent (€) UKPrice


The Impact on Oil Producing Countries

Dollar Devaluation:Causes inflationReduces purchasing powerIncreases cost of operations if spare parts are imported from Europe and Japan

This would reduce upstream investment.It will apply to US oil companies operating in OPEC.

See next 14 figures on the relationship between dollar devaluation and inflation in the oil producing countries


Inflation and Oil Prices (Saudi Arabia)

0

20

40

60

80

100

120

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

-4

-3

-2

-1

0

1

2

3

4

5

6

Dollar Index Inflation in SA

Gulf War

%$ Index


Inflation and Oil Prices (Oman)

0

20

40

60

80

100

120

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

-10-8-6-4-2024681012

Dollar Index Inflation In Oman

Gulf War

%$ Index


As the dollar increases, inflation decreases: Saudi Arabia

Inflation and Dollar SA

-4-3-2-101

23456

60 70 80 90 100 110 120

%

$


OmanInflation and Dollar Oman

-10-8-6-4-202468

1012

60 70 80 90 100 110 120

%


QatarInflation and Dollar Qatar

-2-10123456789

10

60 70 80 90 100 110 120

%


UAEInflation Dollar UAE

0123456789

1011

60 70 80 90 100 110 120

%


BahrainInflation Dollar Bahrain

-3-2-1012345

60 70 80 90 100 110 120


AlgeriaInflation Alg

-505

101520253035

60 70 80 90 100 110 120


IranInflation and Dollar Iran

0

10

20

30

40

50

60

60 70 80 90 100 110 120


Nigeria

Inflation Nigeria

01020304050607080

60 70 80 90 100 110 120


RussiaInflation Russia

-500

0

500

1000

1500

2000

60 70 80 90 100 110


Colombia

Inflation Colombia

05

101520253035

60 70 80 90 100 110 120


AngolaInflation Angola

-1000

0

1000

2000

3000

4000

5000

60 70 80 90 100 110 120


Observations1. The exchange rate-inflation effect declines as the

percentage of oil exports in total exports declines.

2. The relationship between dollar devaluation and inflation in the oil producing countries does not hold if:

The local currency is not pegged to the dollarThe economy is diversifiedThe dependence on oil is small

Norway, Indonesia, Gabon, and MexicoOut of 18 oil producing countries, only four countries found not have an inverse relationship between the value of the dollar and inflation.


Loss of Purchasing PowerThe Following Figure shows OPEC basket prices (red), prices adjusted for exchange rates (Green), and Prices adjusted for exchange rates and import prices (blue).Losses due to import prices are much larger than losses (some times gains) due to exchange rates.OPEc should address import prices rather than currency exchange rates!


Loss of Purchasing Power

10

15

20

25

30

35

40

Jul-9

0

Jan-

91

Jul-9

1

Jan-

92

Jul-9

2

Jan-

93

Jul-9

3

Jan-

94

Jul-9

4

Jan-

95

Jul-9

5

Jan-

96

Jul-9

6

Jan-

97

Jul-9

7

Jan-

98

Jul-9

8

Jan-

99

Jul-9

9

Jan-

00

Jul-0

0

Jan-

01

Jul-0

1

Jan-

02

Jul-0

2

Jan-

03

Jul-0

3

OPEC Basket Price Adjusted for Exchange Rates Adjusted for Infaltion$/b


Loss of Purchasing PowerThe following two Figures show oil prices after adjusting them for purchasing power (adjusted for import prices and exchange rates) for three OPEC members. The US real price of oil (adjusted for US inflation) is added for comparison.

OPEC members have different trading partners. Therefore, the effect of dollar devaluation differ from one country to another.


Purchasing Power Oil Prices

0

2

4

6

8

10

12

14

16

18

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

Indonesia Venezuela UAE US


Real Oil Prices (constatnt 1970)

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

1975 1980 1985

Saudi ArabiaUAEKuwaitLibyaIndonesiaVenezuelaUSA


ResultsDollar depreciation reduces activities in upstream through different channels including lower return on investment, increasing cost, inflation, and purchasing powerDollar devaluation increases demand in countries with appreciated currencies because of increase in purchasing power.Dollar devaluation increases demand in the US as tourists prefer to spend their vacations in the US.


ResultsStudies that focus on demand elasticities must use oil prices denominated in national currencies, not in US dollars.Studies that focus on the relationship between energy prices and economic growth must use oil prices denominated in national currencies, not in US dollars.Exchange rates may explain several issues in international energy markets that researchers are not able to sort out or agree on.

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