Impact of Weak Dollar on Oil Prices

Around the world there is anguish about the high oil prices , but if political leadership n policymakers want lower oil-prices then they should b promoting policies that strengthen the dollar. While oil-exporting countries receive revenues in dollars , they use different currencies to import goods & services from other countries . Any change in the exchange rate of the dollar affects the purchasing power of these countries and therefore their real income. Similarly international oil companies sell most of their oil in dollars, but they opearte in several countries and pay their costs in local currencies. Any change in the value of the dollar therefore affects their cost-structure and profitability which in turn affects reinvestment in exploration,development and maintainance.

Short Term effects : In the short-term dollar depreciation does not affect supply and demand but it does lead to speculation and investment in oil-futures markets. As the dollar declines,commodities(including oil)attract investors.Investing in futures becomes both a hedge against a weakening dollar and an investment vehicle that could yield substantial profit , particularly in a climate of vanishing excess oil production capacity,increasing demand,declining interest rates,a slumping real estate market and crisis in banking industry.

Long Term effects : In the long run,however, statistical analysis of various oil industry variables indicates that a weak dollar affects supply by reducing production. A weak dollar also affects demand by increasing consumption.The result of a decrease in supply and an increase in demand is higher prices. The lower dollar also reduces the purchasing power of oil exporters. If nominal oil prices remain constant while the dollar declines,the real income of the oil-producing countries declines,resulting in less investment in additional capacity and maintainance.The same is true for oil companies .Consequently oil prices increase. Infact since the oil prices were rising while the dollar was declining,capacity expansion by oil firms failed to meet forecasts for non-Opec production in the last three years. Even oil production in the United States has not matched the increase in oil prices, as rising import costs for tools and equipment --a reflection of dollar's weakness--have forced project delays and cancellations.

Indian perspective : Flagship refiner-marketer IndianOil Corporation posted a Rs 414.27 crore loss in Q4 as against Rs 1,502.69 crore profit last year . This is the first time that the highest ranked Fortune 500 company(rank 135) from india has posted a quarterly loss since 2005. The company is losing Rs 300 crore per day on sale of diesel , petrol, cooking gas and kerosene and would run out of cash to even import crude oil by September-end if fuel prices are not raised or duties cut . The loss on fuel sales has forced IOC to put on hold all new projects , the largest on-going project at Paradip has been split so that only refinery will come up first.

This being an election year , the goverment, already smarting under a slew of electoral defeats and rising inflation,doesnt want to risk a petrol price hike. Instead indirect measures to absorb price differential r being considered.The government is looking for a political solution to what is essentially an economic problem.Its to be understood that oil is essentially a global commodity that doesnt come free. Political parties must understand that there are no free lunches in this globalised world. Non-action would mean crippling fuel-shortages and will have gross fiscal implications, as such the Oil-Bonds are an off-budget item and jeopardize india's fiscal prudence measures.Its high time we went back to policy of revising oil prices every fortnight.Regular revision would obviate the need to contemplate steep price hikes.It would de-politicise oil. In tandem it would make sense to rationalise taxes and duties on petrol and diesel. It is hugely distorting to continue with the same duty cuts irrespective of whether the price of crude is $90/barrel or $ 135/barrel. Given flaring oil prices,ad valorem duties only mean needless windfall tax gains. Such anomalies encourage diversion of subsidised kerosene for adulteration and discourage development of alternatives like battery-powered and hybrid vehicles.Global prices have cooled-off in last couple of days ,though it is too early to confirm a trend but if they do decline substantially in next few months ,goverment can surely pass on the benefit to consumers by lowering price if it goes for a hike now .
from ET and BS