Oil, as the world’s most heavily-traded natural resource and the bedrock foundation of some of the planet’s largest economies, has always had a strong impact on virtually every area of economics and finance. The global oil trade is estimated to be worth something in the region of around $4 trillion a year in revenues, or about 3.8% of global GDP.
Therefore, it should not come as a surprise that fluctuations in crude prices have a significant impact beyond energy markets.
One area where oil prices have an outsize, global impact is on currency values. Virtually every national currency in the world is regularly impacted by developments within oil markets on an almost daily basis. Here’s how.
Oil-Producing Economies and Currency Prices
One of the most apparent correlations between currency prices and oil can be seen in countries that produce and export oil as a major component of their economies.
Such countries are naturally very dependent on high oil prices, meaning that a collapse can have the effect of eroding the value of their national currency.
When explaining what is forex trading and how does it work, it is important to bear in mind that the value of currency pairs is largely based on the economic performance and standing of the countries involved. Currency traders will often look at national economic developments to predict a correlating fall or rise in the value of currency pairs.
When a country that is heavily dependent on oil exports, such as Russia or Saudi Arabia, experiences a collapse in oil prices, a correlating collapse in the value of their national currency, compared to currencies such as the US Dollar, nearly always follows. When oil prices are high, such countries often experience a rise in the value of their own currencies; which can be both a good and a bad thing.
The relationship between dollar and oil prices
Why is oil traded in US dollars only?
The United States of America is the largest producer and exporter of oil in the world, so it makes sense that the US dollar would be impacted by global oil prices. However, the US economy is not very dependent on oil exports, which actually only makes up a small percentage of GDP.
More important is the fact that crude oil prices are always quoted in US dollars. This means that no matter where you are in the world, you are essentially trading for oil in dollars.
As a result, the price of oil is inversely related to the price of the US greenback.
How does a strong US dollar impact other countries?
When the value of the dollar is high relative to other currencies such as the Euro and the Japanese Yen, you need fewer US dollars to pay for a barrel of crude. However, when the value of the dollar is low, more dollars are needed to pay for that same barrel.
While this is good news for the US, it can be bad news for countries that are net importers of oil, such as Japan or the UK. Such countries can find themselves paying more for oil depending on the fortunes of the US dollar. Although some have argued that the US dollar’s strong impact on the cost of oil is now loosening, it is still a vital consideration in energy markets around the world.
There is no denying that oil remains the world’s most important commodity for a number of reasons. The close correlation between crude oil prices and currency values will continue to shape economic trends for decades to come.