April 22, 2008

Every time we go to fill up our cars with petrol it is a new disappointment, with prices increasing every day, the cost of motoring is rising at an unprecedented pace.

There are a number of reasons for this increase; supply and demand have radically changed in recent years. The huge increase in demand from Asia, China and India in particular, are consuming oil at a phenomenal rate.

Oil is traded as a commodity and as there is a finite amount of it, the price naturally increases as supplies are used and stocks reduced. However these aren’t the only reasons for the increase in oil prices recently. One of the main reasons for the current breakneck price increase is the plummeting value of the US dollar.

If we cast our minds back to November 2002 when the Euro was worth less than a dollar, OPEC’s purchasing power was served well by the US currency. The Euro zone countries represent the biggest source of OPEC imports, so the exchange rate between U.S. dollars and euros is critical to OPEC finances.

With the Euro currently being traded at a rate of $1.6, anything that OPEC producers wish to purchase from the Euro zone will have, in effect, increased in price by 60%, from the depreciation of the dollar alone.

With the credit crunch currently ravaging US consumer confidence and seizing up money markets, the collapse in value currently being felt by the dollar shows no sign of abating. This is terrible news at the pumps as it will mean that oil prices will continue to rise, merely for oil producing countries to retain the value of their product.

The current signs of trouble in the US economy should have OPEC rushing to price oil in a more stable currency. We look to be at the start of a vicious cycle of devaluation. Every dollar increase in the price of a barrel of imported oil increases the size of the U.S. trade deficit, which puts more pressure on the value of the U.S. dollar, which leads to a weaker dollar, which makes OPEC countries want to raise the dollar-denominated price of a barrel of oil to make up for the dollars fall, and so on.

Without addressing the US budget deficit it is likely that the price of oil and therefore petrol will continually increase.

OPEC cannot affect any change in the value of the dollar, they can only take control of the currency that oil is traded in. So in order to regain control of their products worth, the only measure that is available to it, is to price it in a stronger currency.

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