Oil and a falling dollar?
Over the past few weeks, the dollar has been rising just as the price of oil has fallen, setting off much speculation about the implications of both in these interesting economic times. The phenomena are interlinked to an extent, and both have some ramifications for Oman

By Oliver Cornock

On August 6, the dollar rose to a seven-week high and $108.48 against the yen, and a day later hit a five-month high of $1.51 against the euro, a trend that leads some to suspect that the worst may be over for the greenback. On August 5, the Federal Reserve had opted to freeze interest rates at two per cent, having been faced with the unenviable squeeze between inflation at a 25-year high on the one hand and slowing growth and a potential housing crisis on the other.

While Fed chief Ben Bernanke and his fellow Americans sweat about soaring prices in a difficult economic climate, others can breathe a little easier. Among them, the central bankers of the Gulf, who over the past year have watched their currencies drop along with the greenback to which their currencies are pegged (with the exception of Kuwait) and have cut interest rates in line with the Fed.

Domestic impact
Dragged down by the dollar, the rial has weakened, driving up the price of imports denominated in other currencies – particularly the euro. Furthermore, while the Fed’s rate cuts have been designed to stave off recession in the US, they have been wholly inappropriate for Oman, which has been experiencing inflation driven by an influx of liquidity, growing populations and rising import costs.

It is then no surprise that the dollar’s strengthening will be greeted with some relief in the Sultanate. The question is whether the trend will continue. The provisional answer is a cautious yes. According to recent US figures, despite the slowdown, productivity has grown at a respectable 2.5 per cent so far this year – hardly a recession. This, and evidence from bodies including the IMF that the global slump may not be as bad as predicted, may convince the Fed that further rate cuts are not necessary – or desirable, given inflation.

Meanwhile, the euro’s outlook continues to weaken. Some 14 out of 15 countries in the eurozone reported that their manufacturing contracted in July, as the economic slowdown began to bite deeper. Bad news for Europeans – but another factor easing price pressure in Oman. If the dollar continues to strengthen and the Fed stays its hand – or even increases rates, as some hawks are advocating – speculation over whether Oman and its neighbours should de-peg their currencies should also ease.

Slide in oil prices
So far, so good. The dollar’s rise, however, has coincided with drops in the price of crude oil. They are not unconnected. Oil’s sharp fall from its record $147 per barrel on July 11 to around $120 has led many to conclude that recent price rises have been driven as much by speculation as by other factors that have been cited, such as high demand in China, tight supply and geopolitical instability. Now investors may be turning to the old faithful, the greenback, as oil heads south. Even without the speculative element, the strengthening of the dollar should put downward pressure on oil prices.

Is this the flipside for Oman? For the past few years, the Sultanate has reaped the benefit of high oil prices, enabling the country to invest heavily in its diversification drive and infrastructure developments – and to mitigate some of the effects of inflation through a generous subsidy and public wage regime. Furthermore, investments in oil extraction technology and exploration have been made with the assumption that they will be cost-effective.

Oman’s authorities will be watching the fall in oil prices particularly closely due to the relatively high extraction costs in the Sultanate. Both geology and the type of crude found in the Sultanate push the cost of producing a barrel of oil up to as much as $10 – compared to as little as $2 in Saudi Arabia. Due to this fact, as well as Oman’s careful and incremental development of its oil industry in the past, the Sultanate has only recently started earning a large oil export income. A prolonged continuation of the sharp drop in oil prices would cut into margins and raise worries that the country could not fulfill its investment commitments, and even that it would run the risk of being lumbered with white elephant oil sector projects.

A troubling scenario, certainly – but, for the foreseeable future, an unlikely one. The oil price would have to drop drastically for Oman to be seriously hurt – and that seems very unlikely.

Oil price remains very high by historical levels (even taking into account increased global purchasing power). Recent remarks by a Kuwaiti oil official that crude was unlikely to fall below $100 a barrel indicate confidence from a leading OPEC member that a price crash is off the cards, while a report by Chatham House has asserted that the long-term trend is still upwards, to $200 in the next five to ten years. Global demand for oil remains high, and a realistic replacement for it is still some way off. Supply, for the time being, remains relatively tight, and indeed Chatham House warns that it may soon be insufficient.

Looking for options abroad
What is more, the Oman Oil Company (OOC) has made some shrewd moves in recent years to secure its future. Investments in “tertiary” methods of oil extraction – a necessity in Oman – have made OOC a world leader in this technology. When the easily-accessed main fields of other major oil producers start to dry up, and attention turns to more geologically problematic sources, tertiary extraction should become more widespread. OOC will be in a prime position to benefit. This may be one of the drivers behind corporation’s acquisition, earlier this year, of an eight per cent stake in Hungarian energy firm MOL. The firm MOL, in exchange, reportedly received minority shares in some OOC assets – and it would have made sense for the Hungarian firm, anxious for its future, to look into tertiary extraction.

For OOC, the deal was also a smart strategic move. Not only did it broaden the firm’s base outside the Sultanate and give it access to downstream capabilities, it also potentially gives OOC a partner – and therefore hedge – for further investments in oil exploration in Oman. While the future looks positive, it is not certain, and sharp drops in price like the ones seen recently may give the market jitters, which can be better withstood if risk is shared. The dollar and crude oil have again given the world pause for thought. For Oman, the fortunes of which are still closely tied to both, the message still is: steady as she goes.

The author is Regional Editor, Oxford Business Group


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