How Many Dollar$ per Barrel
July is an important month for Americans in oil and gas exploration and production. Each year we celebrate the birth of our nation, 239 this year. July 2015 we also celebrate one (1) year from when NYMEX WTI traded above $100.
July 3, 2014 NYMEX WTI Light Sweet Crude Oil Futures (CL) settled at $104.06. That same day the Dollar as measured by the U.S. Dollar Index® Futures (DX) on Intercontinental Exchange (ICE) settled at $80.281.
Energy professionals are intimately familiar with crude oil’s decline in the year since we last celebrated our nation’s birth. Mainstream media has attributed falling energy prices to the high rig count, record production, record storage, refinery strikes/outages, and occasionally weak demand, all of which affect hydrocarbon prices. On rare occasions the dollar is included in the discussion.
Crude oil an internationally fungible commodity denominated in U.S. Dollars and thus there is a defined mathematical relationship between the U.S. Dollar (DX) and NYMEX WTI (CL), specifically an inverse relationship.
Correlation is a statistical term that helps show if and how strongly two (2) instruments are related. Investopedia defines it as a statistical measure of how two securities (instruments) move in relation to each other. Specifically correlation quantifies how the change in two instruments is related to each other.
Correlation is positive when two (2) instruments increase by similar amounts in relation to each other. If the price of corn rises 1% and the price of wheat rises 1% at the same time those crops are positively correlated
Figure 1 Positive Correlation
Correlation is measured in a range from -100 to 100 or -1 to 1 depending on the calculation and convention and is frequently referred to as “R Value” or just “R”. Any correlation greater than 0 is positive correlation and the higher and closer to 1 or 100 the more significant the relationship. Correlation of 1 or 100 is perfect positive correlation with anything more than .5 or 50 considered strong.
Inverse or Negative Correlation
If two instruments move opposite each other by same or similar amounts they are negatively correlated. Returning to the corn and wheat example if corn rises by 1% and wheat decreases 1% they are negative or inversely correlated.
Figure 2 Negative Correlation
Negatively correlated instruments have an R-value less than 0 with -1 or -100 being perfect inverse correlation. An R less than -0.5 or -50 is a strong inverse correlation.
Corn and wheat have a strong positive, near perfect, correlation of 88.88. So what does that have to do with dollars and barrels, this isn’t the farm blog? The relationship between dollars and barrels is much different than that of corn and wheat
Crude Oil and Dollars
The background mentioned the settlement prices for Dollars (DX) and crude oil (CL) when we last celebrated Independence Day, how does that compare to this year?
July 3, 2014
July 3, 2015
The decrease in NYMEX WTI has been more significant than the increase in the Dollar, but their inverse/negative correlation is obvious and quantifiable. The following analysis uses Updata Analytics and data from CME Group and ICE via ESignal/Interactive Data.
The change in both instruments is most evident when their prices are visually compared in the following chart with NYMEX WTI in the top pane and the Dollar Index in the lower.
Chart 1 NYMEX WTI vs. Dollar Index, Source ESignal, Updata Analytics
The historical negative correlation is only marginally evident in 2012 and 2013, but from the middle of 2014 to date the charts are almost mirror images.
Dollar Index (DX) and NYMEX WTI (CL) Historical Correlation
The historical inverse relationship between the dollar and crude oil is displayed in Chart 2. Crude oil is on the vertical axis and Dollar Index on the horizontal.
Chart 2 DX – CL Historical Correlation, Source: ESignal, Updata Analytics
The inverse relationship is obvious in the red downward sloping line that intersects the scatter diagram of NYMEX WTI versus Dollar Index prices.
The historical R-value of the relationship is (79.31), not a perfect inverse relationship, but it does demonstrate strong negative correlation of the two instruments.
Dollar Index (DX) and NYMEX WTI (CL) 1-Year Correlation
Comparing NYMEX WTI to the Dollar Index the inverse relationship is most evident in the second half of 2014 extending into 2015. The increased correlation during the past year is quantified in Chart 3.
Chart 3 DX – CL 1-Year Correlation, Source: ESignal, Updata Analytics
Chart 3 is much more neat and symmetrical than Chart 2 owing to the more significant negative correlation between NYMEX WTI and the Dollar Index (DX). The R-value for the past year is (92.34) a near perfect inverse relationship.
The more negative correlation between the dollar and oil during the most recent bear market in oil cannot be overstated. While the two have a measurable historical inverse correlation the past year has nearly perfected the relationship.
The next logical question is which instrument follows and which leads? Did oil’s decline lead to the dollar’s rally or vice versa. It isn’t easy to know the answer; they are both driven by global macroeconomics. The Federal Open Market Committee (FOMC) heavily influences the dollar and the past year speculation about if/when the FOMC will start raising short-term interest rates has been the driving macroeconomic factor.
Conventional wisdom (two most dangerous words in trading) is that the FOMC will raise short-term rates later this year and gradually thereafter lending support to the dollar. If that is the case expect more downward pressure on crude oil. If the FOMC delays raising rates and the dollar falls crude oil can be expected to climb.
Until the FOMC question is resolved expect more volatility. To quote Mike Brown at Palmares Energy: “We are all FOREX traders now”.
Crude Oil – Dollar Summary
The rapid decline in crude oil prices and subsequent volatile rebound has been attributed to many things, most all of which are contributing factors, by the mainstream media. One key factor has been mostly left out of the discussion – crude oil’s inverse relationship to the dollar.
There have been many days with no announcements or economic reports where oil moves dramatically, like July 3, 2015 NYMEX WTI settled down $1.41 or (2.48%) and there were no OPEC meetings, storage reports, rig count releases, peace treaties signed, or other economic news flow. The Dollar Index settled up 0.11 or .11% and sometimes that is all it takes to help generate weakness in crude oil.
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