In the absence of the US markets yesterday saw a relatively quiet trading. Global equity prices inched higher but further strength is far from guaranteed. All eyes will be kept on US tech stocks and the Nasdaq index as investors will be keen to get a feel of Softbank’s intentions. Any hint of liquidating the long call option positions built up over the last month or two will be met with fresh selling. Such a development would drag oil down with it. Softbank’s shares have lost 11% of their values since last Wednesday although Asian markets are stable this morning.

Not that the black gold is encouraging on its own right. The energy complex drifted further lower yesterday in what was the fourth consecutive daily loss, an unheard feat since April. The main catalyst behind yesterday’s softness was the publication of the October official selling prices from Saudi Arabia. The kingdom has decreased its differentials to all destinations for next month. Its most important market, Asia, will see a drop of $1.40/bbl, from 90 cents/bbl over the monthly Oman/Dubai average to 50 cents/bbl below it. It is the second monthly cut in a row and considering that outright prices are currently $3-$4/bbl lower than a month ago Saudi crude heading towards Asia next month could be $5-$6/bbl cheaper in absolute terms than in August.

Apart from the US stock market performance the EIA will have a profound impact on the formation of oil prices this week. Both the monthly Short-Term Energy Outlook and the Weekly Petroleum Status Report will be published a day later than usual due to yesterday’s bank holiday (Wednesday and Thursday). The former will provide us with an update on US crude oil output for the balance of this year and for 2021. The latter will deal with the aftermath of Hurricane Laura. US production is not expected to reach the pre-storm level as producers are still in the process to ramp up production in the Gulf of Mexico, however, crude oil imports are expected to rise. An upward revision in domestic output estimates in coming months and a weekly build in crude oil stocks coupled with sluggish demand figures will confirm that the oil market has, in fact, broken out of the recent trading range on the downside and will put further pressure on prices. 

Recent dollar weakness has been swept aside

The world’s reserve currency has a great effect on regional economies and on the price of raw materials, including oil. As most governments holds a significant portion of its debt in dollar it becomes more difficult to service this debt when the greenback is strong and vice versa. Equally, weak local currencies make it more expensive to purchase raw materials and serve as an incentive for producers to increase outputs denting demand and increasing supply. A falling dollar achieves the opposite result.

As with so many indicators, the US dollar has been failing to fulfil its widely accepted role in the global economy. There are a few reasons for it. Firstly, its status as one of the safest havens has been ignored since the US economy is under possibly greater strain than other developed countries due to the shambolic handling of the pandemic. Secondly, the recent dollar weakness has not been general: whilst it has been losing value against a basket of OECD currencies it has remained relatively stable against emerging markets.

After the European Union agreed on the details of the €750 billion European Recovery Fund to support the ailing economy of the region the common currency received a timely boost. It strengthened from 1.12 against the dollar to 1.20 by the end of August yet this dollar weakness or euro strength failed to provide meaningful boost to oil prices. Brent firmly remained around $43-$45/bbl in these two months. Once again, it is because the economic impact of the coronavirus (sluggish growth, high unemployment) puts a break on oil demand. It is equally noticeable that the Chinese currency strength -the Yuan strengthened from 7.16 to 6.83 in the space of three months- also failed to generate additional demand for oil. The latest indication of stalling Chinese oil consumption is the declining August crude oil imports compared to June and July.

Other emerging market currencies do not fare so well. The Russian rouble, for example, has been constantly weakening and is now above 75 against the dollar from below 68 at the beginning of June. No wonder that Russian oil production rose in August (in line with the increased quota) and the country’s energy minister is talking up the prospect of global oil demand growth in order to increase supply and maximize the benefit of the weak rouble.

It is an unusual situation where the bullish demand impact of the dollar weakness is ignored, and the bearish effect of its strength is magnified. It is perfectly plausible that the dollar index, which fell from over 100 in May close to 90 in August has found a bottom recently. This is primarily because the euro weighs the heaviest in the index and the European Central Bank will want to avoid protracted euro strength in its attempt to perk up inflation. The ECB is clearly worried that the strong euro will act as a break on the region’s economic recovery and will do what it can the limit further euro strength. The bank’s governing council meets this week to discuss monetary policy.

The U-turn of the latest trend will also have an adverse impact on the US economy. Weak dollar helps reducing US trade deficits, or at least slows down the ever-growing gap as it enhances US exports competitiveness and hinders imports from advanced economies. A renewed strength in the greenback will reverse this tendency further acting as a temporary break on US economic prospects. The dollar that peaked above €1.20 last week is back at €1.18. As mentioned above, the dollar index is also showing signs of bottoming out. If the renewed strength in the green-back turns out to be more than just a temporary phenomenon a quick recovery in oil prices will remain wishful thinking. A weak dollar has failed to provide price support, but the strengthening of the US currency could well contribute to renewed downside pressure in oil prices, at least in the short-term.