What Else Moves the Price of Oil

Assuming my correlation analysis was correct, the price of oil—a globally traded commodity—is the prime driver behind the price of a gallon of gasoline.  No stretch there.

What else besides demand moves the price of oil?  What do you mean?  Markets for commodities can be subject to several factors not the least of which are the relative value of currencies and traders taking positions that make markets. 

Relative value of currencies?  A dollar is a dollar right?  Just like a dollar today will not buy the same amount of goods that a dollar did twenty years ago, it may or may not buy the same level of goods in another country.  However, oil is a commodity that is commonly denominated in dollars.  The theory goes that as the value of the dollar decreases vis a vis other currencies traded freely internationally that the price will rise regardless of supply and demand to account for this weakness.  The counter is true that as the value of the dollar increases vis a vis other currencies traded freely internationally the price of oil will decline.

Does the data bear this out?  Without reinventing the wheel I will map the price of oil and the U.S. dollar index (DXY).  DXY is a measure of the U.S. dollar’s strength relative to a weighted basket of currencies.  Here is what the chart looks like:

Nothing to see here?  Not so fast.  Just as things can be positively correlated, as was the case with the price of gasoline and the price of oil, things can also be negatively correlated.  In this case the correlation coefficient is (0.77).  Which says that as the value of DXY increases the price of oil decreases.  It is not as strong as the correlation between the price of gasoline and the price of oil, but it is still strong.  Especially considering the size of the data set.  NOTE: As a rule, DXY trades in a much more narrow band than the price of oil, so the graphical representation is less than illuminating.

Getting at the concept of speculation’s impact on the price of oil is much more difficult.  There is no accepted metric that measures the level of speculation in a market in any concrete way.  Market watchers like to point to volatility as a measure of speculation or the level of trading, but those metrics fail to have a great level of correlation with the underlying price data.

Given that environment, the disconnect between the price of oil and the common levers of demand or dollar strength/weakness gives rise to the feeling that speculation is now one of the levers that impacts the market up and down.  I think that you see this in the massive decline in the price of oil in the second half of 2008 as speculators got out of positions and the price bottomed out.  Apparently, Bernie Sanders thinks there is a problem and I tend to agree with him.

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