The Real Reason Oil Prices Plunged

By MarketsFOXBusiness

One chart tells a powerful story about world oil prices.

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World oil prices are denominated in U.S. dollars. When the dollar is strong, when it increases in value, oil becomes cheaper. Yes, world oil players are producing more oil than consumers are using, supply is up due to the U.S. shale oil boom and the halting return of Libya's production. But the dollar story can’t be underestimated—take a look at the chart below put together by FOX Business Senior Editor Charles Brady.

The world is enjoying an oil surplus right now. But the production surplus “is smaller” versus the last time there was a surplus “between March 2012 and March 2013,” says Arthur E. Berman, a petroleum geologist with 36 years of oil and gas industry experience. Despite there being a bigger surplus in 2012 to 2013, the price of oil back then did not plunge as much or as fast as it has since the summer, Berman adds. What gives?

“When the Fed started printing money like crazy after the crash in 2008, the value of the dollar was kept artificially low compared with other currencies,” Berman says. However, the weakening dollar masked the market impact of growing production surpluses in oil.

The US dollar index bottomed in May of last year, and then started to strengthen in July. When the Federal Reserve concluded its six-year program to stimulate the economy, called “quantitative easing,” (QE) with a final $15 billion purchase of bonds on October 29, 2014, you can see in the chart how the dollar really began to strengthen, and oil prices started to drop dramatically (the Fed’s balance sheet is now $4.48 trillion, up from $886 billion in the fall of 2008).

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“The coincidence of the end of QE with the onset of a production surplus (in oil) created a perfect storm for oil prices,” says Berman. “There is nothing especially different about this latest oil-price fall compared to any of the others except the end of QE. It's not really about shale or the Saudi decision not to cut production. It's about a relatively ordinary oil-production surplus that happened at the same time that QE ended.” With the Fed widely expected to raise interest rates later this year, and given the weakness in Europe and Asia (with European central banks getting set to hoist their elephant guns), the dollar will likely strengthen, “continuing to put downward pressure on oil prices,” notes Brady.

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