Weakness of dollar likely to keep oil prices high

Crude oil prices have surged 18 per cent in May as banks raised price forecasts due to limited supply and demand growth, while Organisation of Petroleum Exporting Countries (Opec) ministers said they could not have done anything to halt the rally, which has seen prices almost double during the past year, according to a report by One Financial.

"There seems to be very little Opec can do. Saudi Arabia is probably the only country within Opec with the power to increase supply significantly, but they have no incentive to do so as they are profiting royally along with the other producers. As long as demand holds up, we will not see Opec in a rush to increase production any time soon," said Jamie Craggy, chief analyst at One Financial in London.

Craggy said Libya's Oil Minister Shokri Ghanem chose to blame speculators when he said "we [Opec] are not in charge anymore. Opec is producing as much as the market wants. It is speculation, it is geopolitics, it is the dollar erosion that has led to the price rise".

One Financial has raised its crude oil price forecast for 2008 from $103 to $119 last week, citing continued strong demand as the United States economy narrowly skirts a recession and emerging market economies continue to perform strongly.

"Continued weakness in the dollar is also likely to support crude oil prices over the coming months before the dollar begins to rally in the autumn," said Craggy.

The soaring price of crude has given other commodities a boost in recent weeks. Soft commodities, such as coffee, cocoa and sugar, have moved higher as record crude oil prices have increased costs for producers and processors and prompted investors to buy up commodities as a hedge against inflation.

"We have seen a lot of interest in robusta coffee recently. Crude prices are the main driver of coffee at the moment. Despite the fundamentals pointing to a healthy supply in the market, higher energy costs and the weak dollar are helping to keep prices buoyant," said Craggy.

The weakness of the US dollar has been the headline story for foreign exchange traders for months. However, more and more traders are seeing signs that the dollar may have turned a corner and begin to strengthen through the second half of the year. "We have seen more and more clients buying up the dollar in recent weeks. For months everyone was short of the dollar, but now the tide seems to have turned. Interest rate futures on the Chicago Board of Trade, which we use to get an idea of where US interest rates are heading, show around a 90 per cent chance that the Fed would keep interest rates on hold at two per cent at their next meeting on 25 June, while there is currently a 30 per cent chance that Fed will up rates to 2.25 per cent in September," Craggy added.

"The Australian dollar is probably the most interesting of the major currencies at the moment. It hit a 25-year high verses the US dollar this week and the big banks are forecasting it could reach parity with the greenback by the autumn. This seems highly feasible as the Aussie currency benefits from high oil and commodity prices, which seem likely to continue in the future."

Also, gold moved above the $900-mark again past week after spending most of the few weeks hovering below that figure. Prices have been pulled higher by the soaring price of crude oil, which has led many investors to buy the precious metal as a hedge against inflation. The price of gold has not kept pace with crude oil.

A troy ounce of gold now buys the equivalent of seven barrels of crude oil, which is down from 26 barrels a decade ago. This indicates that gold could move higher as bullion prices have not kept pace with the soaring price of crude oil.

During 2007, gold moved in tandem with crude oil 92 per cent of the time, but in the past two months gold has dropped almost 10 per cent, while crude has gone up 15 per cent.

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