Commodity Modeling and Pricing: Methods for Analyzing Resource Market Behavior

CHAPTER 4

The Oil Price and the Dollar Reconsidered

Sadek Melhem and Michel Terraza

INTRODUCTION

Oil prices have historically been denominated in U.S. dollars. Therefore, the domestic price of oil in the currency of different countries may be quite different, depending on the exchange rate regime. For instance, in the euro zone increases in oil prices were cushioned from January 2002 to November 2006 by the sharp appreciation of the euro. The oil price rose by 211% in U.S. dollars. However, since the dollar depreciated by 44% against the euro, the jump in the oil price was only 115% in terms of euros. Figure 4.1 shows the evolution of the real price of oil in the U.S. dollar zone and in the euro zone, respectively. The dollar devaluation has been a relatively new pressure on the real oil price of crude oil (Amuzegar 1986).

The depreciation of the dollar, particularly against the euro, constitutes a key element in decisions to increase or decrease Organization of Petroleum Exporting Countries (OPEC) production quotas. The fact that the exports of the OPEC countries are denominated in dollars, but their imports come mainly from the euro zone and from Japan (yen), influences the decisions. The devaluation of the dollar against the euro and yen therefore directly affects OPEC members’ economies (Alhajii, 2004; Mazraati, 2005). To maintain their purchasing power, they increase the price of oil. The fact that oil imports are denominated in U.S. dollars raises the question to what ...