Oil Prices Rise as Dollar Weakens

By Greg Flakus

Houston
16 June 2009

Oil prices on the world market have risen steadily during the past two months, going above $70 a barrel and causing concern that high energy costs could slow the economic recovery from recession. Slowing production has contributed to the price increase, but weakness in the U.S. dollar may be the main cause.

At the beginning of this year, energy analysts say consumers in the United States were paying $600 million a day to fuel their vehicles. Today, they are paying around $1 billion a day.  

That is still better than the $1.5 billion a day they were paying a year ago, when the price of oil was around $147 a barrel, but many people are worried that the price may return to that level in the weeks ahead.

Economist and energy analyst Ken Medlock at Rice University's Baker Institute believes that is unlikely. He says prices have been going up in part because market traders are overreacting to any sign of increasing demand.

"The International Energy Agency last week issued a report that projected 2009 demand to be down by 2.47-million barrels a day, rather than 2.56," Medlock said. "The oil market rallied by something on the order of $2 when that news hit the wires."

Medlock says much of the price rise has been caused by the U.S. dollar's slide in value. Crude oil prices on the world market are set in dollars. Medlock says the fundamentals in the market do not justify much more of an increase in oil prices.

"There is a lot of supply being withheld from the market right now. OPEC spare capacity is very high right now," Medlock said. "Demand has not recovered, it is still down, and yet we have seen the price rise by $20 to $25 in the past couple of months."

What could be a problem, Medlock says, is inflation, which would weaken the dollar further and cause the price of oil to go much higher just as the economy is struggling to improve.

"I think that is a really important one to watch, especially in light of the massive amount of spending being done by the U.S. government. Because, at the end of the day, absent some really radical adjustment by the Fed, I think that is going to have to be inflationary," Medlock said. "That does not bode well for the strength of the dollar on international currency markets or the price of oil."

Production cutbacks by the Organization of Petroleum Exporting Countries have helped move the crude price higher, according to Ken Medlock, but the Rice University economist says demand remains much lower than it was a year ago. As for predictions that there may be oil shortages ahead, Medlock is skeptical, but, even if there is a crunch, he says the United States can deal with it as it has in the past.

"One thing we have learned through the history of humankind is that we are very innovative when we need to be," Medlock said. "That is something that has happened since the first and second oil price shocks of the early 1970s and 1980s. We have actually become much more productive from a given quantity of oil and I think that will continue to happen, both from efficiency gains and just simple innovation."

Medlock and other energy analysts note that Americans are not driving as much as they did last year at this time, keeping demand for fuel in check. They say it may be some time before the worldwide economy has revived enough to push up demand and thereby drive another spike in energy prices.