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THIS WEEK'S TOPIC:
INFLUENCES ON PROPANE PRICES

The relationship between
the dollar and crude
By MARK RACHAL
Cost Management Solutions    
Cost Management Solutions
Crude prices ended an uptrend in the middle of 2014 and began a long downtrend that took crude prices from more than $107 per barrel to less than $44 for West Texas Intermediate (WTI) crude in late January. There are signs the downtrend is ending, but fundamental crude remains weak and therefore is vulnerable to falling again.

Crude prices could be getting ahead of themselves with the rally from $44 to more than $53 for WTI. Brent crude is now trading more than $60 for the first time in 2015. Keep in mind, this run has occurred with U.S. crude inventory at record highs. Further, the International Energy Agency (IEA) said last week that the crude inventory of the 26 industrialized nations it represents (primarily crude imports) is likely to reach record highs by midyear.


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Several things have encouraged investors to speculate on crude, even without good fundamental support. We discussed one last week: The sharp drop in U.S. drilling rig activity, which is certain to lead to lower U.S. crude production at some point. In fact, for the week ending Jan. 30, U.S. crude production had dropped by 36,000 barrels per day (bpd) from the previous week to 9.177 million bpd.

However, at the last Energy Information Administration (EIA) report for the week ending Feb. 6, U.S. crude production had bounced back to 9.226 million bpd, up 49,000 bpd from the previous week. As that rebound indicates, there is some risk of crude buyers making assumptions about production at this point, solely based on drops in rig counts. Still, it is safe to assume that decreased drilling will decrease production. The real question is this: How long will it take until that reduction is significant enough to provide the supply/demand balance that will support a sustainable uptrend in crude prices?

Another key element that has given crude buyers the courage to take the long position ahead of supporting fundamentals is the change in the fortune of the U.S. dollar.

Featured photo

The chart above plots the dollar index against the price of crude. The value of the dollar and crude have an inverse relationship, which has never been more evident than during the June-to-January decline in crude prices.

Because commodities are traded in dollars, the rising value of the dollar puts downward price pressure on the commodities themselves. A seller of crude can afford to get fewer dollars for his barrel of crude if the dollars he does get have greater buying power.

As the chart shows, the dollar index was on the rise during the fall in crude prices. The dollar index is a measure of the value of the dollar relative to a basket of foreign currencies. The dollar is compared with a weighted group of six international currencies: Euro, Japanese yen, Pound sterling, Canadian dollar, Swedish krona and Swiss franc.

When crude began its decline, the dollar index was at around 80 cents. By the time crude reached the $44 level, the dollar index was at 94 cents. The dollar was on a strong run because the U.S. economy was improving at a better rate than economies in Europe and Asia, where most of the currencies the dollar is compared with for the index are located. In fact, as the U.S. central bank was moved to tighten its monetary policy from last June until January, other central banks were, for the most part, loosening monetary policy.

But as the chart shows, the dollar index appears to have plateaued. There was even a period of a sharp drop in the dollar index when it appeared the Federal Reserve was going to have to postpone expected interest rate increases later this year as the U.S. economy slowed. Each time the dollar index has fallen over the past few weeks, it has given a boost to crude.

Crude has been in rebound mode since Jan. 29, with the stabilization and fall in the dollar and decreased U.S. drilling rig count being the primary reasons. The rise in crude has supported higher propane prices as well. Propane has been gaining because of supportive weather and rising crude, despite very bearish inventory conditions. If inventory was the only thing propane markets reacted to, there would not be a rally in propane prices at the moment. There are plenty of other influences - from the economy to geopolitics - that can filter down and cause propane to trade in ways that seem contrary to what the current fundamentals would seem to dictate.


WEEK IN REVIEW

Harsh winter weather allowed propane to outpace crude to the upside last week. Crude kept moving higher as traders speculated that reduced drilling activity would cut into crude supplies. The severe weather will keep us bullish on propane to begin the week. However, crude reached its current price level twice since Jan. 29, but could not break higher. Therefore, we will remain neutral on crude.

Featured photo

LAST WEEK'S HIGHLIGHTS
Last Week's Highlights
Propane prices moved higher on crude, with cold winter weather allowing traders to ignore a bearish inventory condition. Speculation that falling U.S. drilling rig activity will cut into crude production and balance supply and demand had crude higher.
Predictions by the International Energy Agency that crude inventories of the 26 industrialized nations (crude importers) it represents will be at record highs by midyear caused crude prices to reverse course and fall through key technical support. Propane followed crude lower, but resisted the fall to the point of only posting about half the percentage loss of WTI crude.
Finally, a slightly above-average draw on U.S. propane inventory was reported by the Energy Information Administration in its Weekly Petroleum Status Report. The report allowed propane to move higher, despite a drop in crude that was due to a larger-than-expected build in U.S. crude inventory. Drops in price by the Organization of the Petroleum Exporting Countries (OPEC) producers as they fight for market share also put downward pressure on crude prices.
A sharp drop in the U.S. dollar gave crude enough support to allow it to overcome technical resistance and move higher. Propane prices went along for the ride. Crude looked extremely weak coming off Wednesday’s selloff, but the dollar and several other supports allowed for the dramatic turn.
Crude kept building on Thursday’s momentum, and propane continued to find support from severe winter weather conditions. Propane set new highs for the year, as did heating oil. U.S. active drilling rigs continued to decline at a rate of about 100 per week.
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