Wednesday, July 8, 2020

Which currencies suffer particularly from the oil price crash

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Frankfurt Normally, oil promises wealth – but currently nobody wants it. For the first time in history, the price of American oil had temporarily turned negative last week. If you wanted to get rid of it, you even had to pay extra. A weak oil price not only affects energy companies, but usually also the foreign exchange market.

If the oil price falls, this typically damages the so-called oil currencies such as the Russian ruble, the Norwegian krone or, to a lesser extent, the Canadian dollar. After these currencies had devalued significantly by the beginning of March, they have recently shown themselves to be relatively robust against the capers on the oil market.

Currencies that are considered to be particularly risky, such as the Turkish lira and the South African rand, have suffered. This is mainly due to the fact that many investors assume that the oil price will soon at least partially recover. But that is by no means certain.

“There is great uncertainty as to how oil demand will develop after the corona crisis,” said Ulrich Leuchtmann, head of foreign exchange at Commerzbank. A longer economic downturn or changes in behavior – such as fewer air travel – could also reduce demand in the long term. “This would then put a greater strain on currencies such as the Russian ruble and the Norwegian krone.” In Russia and Norway, oil and gas accounted for around half of export earnings last year.

Both currencies have lost significantly since the beginning of the year: the Russian ruble lost around 16 percent against the dollar – the Norwegian krone about 15 percent. However, they have been very stable in recent weeks. Since their lows in mid-March, both currencies have appreciated by almost ten percent compared to the US currency – while the oil price has continued to erode.

In particular, the price of the US variety WTI has fallen by more than half since mid-March and fluctuated particularly dramatically. The price for the North Sea Brent, the reference price in Europe, remained more stable, but also fell by over 30 percent in the same period.

South Africa and Turkey are net importers

“The drop in the oil price is currently not affecting the currencies of large producers such as Norway or Russia as badly as usual. However, it is an economic warning signal and means that investors avoid risks, ”says foreign exchange expert Leuchtmann. In the short term, currencies from countries that already have weak fundamentals, such as Brazil, Turkey or South Africa, would be more likely to suffer.

These countries have comparatively high debts in foreign currencies and have had deficits in the current account, i.e. in the trade in goods and services with foreign countries, in recent years. Therefore, investors look at them with special caution. If the oil price falls, investors interpret this as a signal for higher economic risks and therefore avoid these currencies in particular.

South Africa and Turkey are actually net importers of oil. They typically benefit from a lower oil price because this means that they have to pay less for their imports and are thus financially relieved.

However, this longer-term effect is hardly coming into play at the moment because economic life in large parts of the world is currently at a standstill. “Therefore, negative effects due to the low oil price for producing countries are not so noticeable. Conversely, traditional importers only benefit little because they are barely asking for oil at the moment, ”says foreign exchange expert Leuchtmann.

However, the question is whether it will stay that way or whether currencies from oil exporters such as Norway, Russia or Canada will come under even greater pressure. Bayern LB foreign exchange expert Wolfgang Kiener points out that the current drop in oil prices relates primarily to the short delivery times.

The forward price curve, which shows the oil price at different delivery times, is currently particularly steep. The price at the moment is therefore very low, but it rises sharply the further in the future the delivery time is.

One of the main reasons for this is that oil demand fell suddenly due to the shutdown of many economies. The oil supply, however, cannot be restricted so quickly. The oil state alliance Opec and other countries allied with it have agreed on a strong cut in production.

But it takes a while until this is implemented. In addition, many experts expect individual shale oil producers in the United States to disappear from the market. But that also takes time. The gap between supply and demand is currently very large, which is why storage capacities are becoming scarce – especially in the USA. That explains the currently extremely low oil price.

Many investors are currently expecting the gap between supply and demand on the oil market to slowly close again in the coming months, for example because the cut in production is taking effect, oil producers are disappearing from the market or because demand for economic activity is picking up again in many countries. The steep forward price curve for the oil price reflects this expectation.

Above all, the development of demand will be decisive for the oil currencies. In a recent study, Deutsche Bank strategist Robin Winkler examined how strongly oil currencies react to changes in supply and demand on the oil market.

He comes to the conclusion that changes in demand have a significantly stronger effect on their exchange rates. The main reason for this is that if the supply is adjusted, such as the recent cut in production from Opec, the oil price tends to stabilize, but the producing countries also sell less oil. On the other hand, if demand increases, this has a positive effect on the oil price until the production volume increases accordingly.

Without recovery, there are risks

The current oil price is less important for the foreign exchange market, argues Bayern LB expert Kiener. “The currencies of oil-producing countries like Norway or Russia are more oriented towards the medium to long-term price prospects. Should the price of oil fall further for later delivery dates, this would put a strain on the currencies of oil-producing countries. ”

So if the oil market does not recover as planned, there are risks. Kiener does not expect them to enter. “In the medium term, we are slightly positive for the Norwegian krone. We are currently assuming that there will be a market shakeout on the oil market and that the oil price will slowly recover. “

Commerzbank also forecasts an increase in the krona in the further course of the year. One US dollar currently costs around 10.40 Norwegian krone – the euro is quoted at 11.30 crowns. By the end of the year, the institute assumes that the euro exchange rate will remain constant and that a dollar will then only cost 9.91 kronor.

For the Russian ruble, Commerzbank expects a stable development compared to the US dollar. The recently stable ruble exchange rate was probably one of the reasons why the Russian central bank cut key interest rates last Friday by 0.5 percentage points to 5.5 percent.

“If, contrary to expectations, the ruble loses sustained maintenance in the near future, the Russian central bank should not hesitate to offer its local currency a hold, if necessary with a massive rate hike,” writes DZ Bank foreign exchange analyst Sandra Striffler in a current analysis.

Another currency that usually depends on the oil price is the Canadian dollar. It is currently trading at $ 1.39 per dollar. Commerzbank expects it to remain at this level until the end of the year and to depreciate slightly against the euro. The bottom line is that the experts are rather optimistic about the currencies of the major oil exporters. However, the prerequisite is that the oil market is in balance again.

More: How private investors speculate on crude oil betting

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