Everyone Suddenly Wants Higher Oil Prices

In early April the energy industry was shocked to see G20 ministers meeting to endorse an OPEC deal. Not only had some of these countries protested price collusion in the past, or even looked to outlaw it, but many of their governments had been openly vocal in favor of the low oil prices they had now received. What was the cause for the sudden support? A strong U.S. dollar had become a wrecking ball for the global economy at the least opportune time and raising oil prices was one of the few levers to prevent further dollar appreciation.

A key source of U.S. dollars for much of the world remains selling dollar-denominated commodities. At certain points in time, specifically during periods of high oil prices, these countries were able to get enough U.S. dollars that they could also reinvest them globally. During periods of low oil prices these countries receive fewer critical dollars for their own economies and trading partners. This is compounded by a recent lack of dollars flowing from China. In 2018, and with relatively little fanfare, China launched the Shanghai crude contract with the critical difference being that the contract is yuan-denominated. This allows China to de-dollarize their imports at a time when tensions are rising between the two countries and it was a big step in being less dependent on the U.S. (and showcasing their own purchasing power in the region). The contract also removed a key source of dollars in the global system as China is the largest buyer of crude and now many of these sellers are receiving Yuan. All of this is happening at the worst possible time as the entire world suddenly wants or needs more U.S. dollars.

The coronavirus immediately accelerated a flight into dollars as everyone looked for safe havens. Individuals in emerging markets aren’t parting with their dollars and the countries themselves need dollars to pay or service their debt. This is because since the global financial crises, countries around the world have borrowed in U.S. dollars at a rapid pace. It was cheap financing and people weren’t willing to lend to many countries in their local currencies and take on the currency risk. As a result, there is more than $6 trillion in dollar denominated debt in emerging markets. A lot of this debt is coming due in the next few years which means these countries can either pay it back, default, or refinance. A high US dollar impacts every option, and the countries future growth prospects negatively. If a country has to pay more in U.S. dollars, with a currency that continues to depreciate, it means less money for their local economies and this becomes a drag on global growth. This is happening across the world and it’s so widely telegraphed that it’s only causing more entities to hoard their dollars or rush into the trade.

There are few things strong enough to get out of this feedback loop as the U.S. currency appreciates against everything. That this appreciation is happening against a backdrop of record stimulus proves just how quickly excess dollars get mopped up due to these current factors. One of the last remaining options is a continued increase in the price of crude, as that would help rebalance the system, but it may not occur in time regardless of how many global actors are now supporting it.