Crude oil, often referred to as “black gold”, is the world’s most heavily traded commodity, underpinning the economies of some of the largest global powers. With an estimated annual market value of over $4 trillion, crude oil profoundly influences numerous financial sectors, including the forex market.
With your Funded Account, you can trade oil and forex, as well as other markets. Make sure to read on and learn how these assets influence each other.
The Impact of Oil on Fiat Currencies
Given its enormous market value, it is no surprise that oil extends its influence beyond the energy sector into the realm of global currency trade. This impact is particularly pronounced in relation to the two primary types of crude oil: North Sea Brent (Brent, UKOIL) and West Texas Intermediate (WTI, USOIL). The prices of these two crude oils affect many major currencies. For instance, the Canadian Dollar (CAD) has a positive correlation with WTI oil prices. Crude oil prices can also significantly affect emerging markets. While falling commodity prices can benefit first-world economies, they can be devastating for countries that rely heavily on energy exports.
The United States’ shift from being a net importer to a net exporter of petroleum in 2020 and becoming the second-largest global energy producer, helped bolster its economic growth and reduced reliance on oil imports. The result is a stronger US Dollar. Despite rising oil prices following geopolitical events like the invasion of Ukraine, the USD has benefited from its economic diversity and safe haven status during periods of inflation and global uncertainty.
Countries that produce and export oil as a significant part of their economy are particularly vulnerable to changes in oil prices. For example, if oil prices were to fall sharply, it could severely damage the economies of such nations and reduce the value of their currencies. The Organization of the Petroleum Exporting Countries (OPEC), led by Saudi Arabia, exemplifies this dependence. If Saudi Arabia’s oil exports were to decline drastically, the value of the Saudi riyal would plummet due to its tight link to oil revenue, leading to economic instability.
Oil Prices and the US Dollar (USD)
Many financial experts consider the U.S. dollar to be evolving into a “Petrol currency,” similar to the currencies of oil-exporting nations like Russia, Canada, and Norway. The price of oil is intricately linked to the price of the USD. As oil prices rise, the USD often weakens, and vice versa. This correlation is particularly evident in the USD/CAD currency pair, as Canada is a major oil supplier to the United States. Increased demand for oil in the U.S. leads to higher oil prices and a stronger Canadian dollar, thereby causing the USD/CAD pair to fall. Conversely, a decrease in oil demand in the U.S. can weaken the Canadian dollar, causing the USD/CAD pair to rise.
Furthermore, crude oil is quoted in USD, which means that countries importing oil pay for it in USD, while exporting countries receive payment in USD. This petrodollar system emerged in the early 1970s after the collapse of the Bretton Woods gold standard. As a result, movements in the dollar or oil prices lead to immediate adjustments between the USD and various forex crosses, with stronger correlations in countries with significant oil reserves like Canada, Russia, and Brazil.
Global Oil Prices as a Key Forex Market Driver
Oil is one of the most crucial commodities worldwide and will continue to shape economic trends in the coming decades. This commodity’s price actions can cause corresponding reactions in currency markets due to factors such as resource distribution, trade balance, and market psychology. Moreover, crude oil’s influence on inflationary and deflationary pressures intensifies these interrelationships, especially during periods of strong market trends.
Over-Dependence on Oil Exports
Countries heavily dependent on crude oil exports, such as Russia, have faced significant economic challenges due to oil price fluctuations. Sanctions and geopolitical tensions have further exacerbated these challenges, leading to economic contractions and currency devaluations. For example, Russia’s economy contracted significantly following its invasion of Ukraine, illustrating the risks associated with over-reliance on oil exports.
The Bottom Line
Crude oil exhibits a tight correlation with many currency pairs due to several factors: the commodity is priced in USD, nations’ economic dependence on oil exports, and the broader impact of oil prices on global inflation and deflation. While crude oil can provide valuable insights into forex market movements, it is crucial for traders to consider other economic indicators and geopolitical factors when analyzing currency trends.
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