Do low US dollar interest rates cause a decrease in oil production?

Question

I've just read an article where the author argues that keeping the US dollar interest rate below the inflation rate will most likely cause a decrease in oil production. Here is what he says:

Another factor limiting oil supply today (and thus driving up prices) is that the return to oil producers from the dollars they would earn from increasing production has over the past year been greatly reduced by the US Federal Reserve. American interest rates are now negative in real terms. It is thus rational for oil producers to limit their accumulation of rapidly depreciating dollars by limiting the rate at which they extract oil. High oil prices are therefore at least partially a consequence of an expansionary monetary policy in the US.

When it comes to oil prices, and how much oil is produced today, it might be best to listen less to traders on commodity markets and more to the suppliers. King Abdullah has recently been quoted as saying that if additional oil were to be found in his country, he would advise leaving it in the ground because “with the grace of God our children might have a better use of it”.

This suggests that suppliers have the impression that it is better for them to delay extraction.

http://www.ft.com/cms/s/0/e3216bae-4daf-11dd-820e-000077b07658.html

Answer 1

Fat Halo offers a cogent albeit lengthy explanation.  I'll try a shorter version.  Low interest rates weaken the dollar and drive up the price of oil.  Note that Goldman Sachs is predicting that oil may spike as high as $200 a barrel.

So why sell oil at $145/bbl today if you can sell it at $200/bbl tomorrow?  Hence the incentive is for oil companies to hold their reserves with the hope of selling it at a higher price.

Answer 2

This is marginally correct.

First because the low interest rate is by itself inflationary, it shows up in the dollar which loses value everyday (also for other reasons). As the value of the dollar go down, you need more dollars to buy the same amount of stuff (eg. a barrel of oil). But this is not the point the article is arguing.

The negative interest rates distorts the yield curve (which is upward sloping). Interest rates (yields) work like an arbitrage between consumption/investment/borrowing and saving/lending. Short term interest rates reflect the "price" of money. So the negative short term interest rates shows that money is cheap (banks get paid to borrow) and encourages hoarding. I give you an example, if you had a big stockpile of rice or wheat which you know people will need and would pay high price to get it. If you take out that stockpile immediately to the open market you will get paid $1 million (dollars with todays value) Of course, you don't need the whole $1 M for your daily consumptions, so you will just hold the rest as cash or deposit it in a bank account for, let's say, 10 years. The problem is that during these 10 years your money (dollars) you had in your account lost much of its "purchasing power" (because of the inflationary effect on the dollar). Today, with that $1 M you could buy a very big house in south of France, but 10 years from now, it wouldn't be even enough to get a small appartment. So during the process, you lost much of your purchasing power.

Now imagine instead that you release your stockpile little by little. Every day the dollar goes dow, the value of the remaining stock goes up (relative to dollars) and you get paid higher price each time you sell, so that at the end you would have been paid more than $1M in (today's) dollars value (but probably the same price compared to another stable currency or commodity - as an example, if we consider gold as a currency, the price of oil did not increase (it in fact slightly decreased) in gold terms)

Therefore, you will not at all be interested selling all of your stockpile today knowing that the money you will be paid will lose value in the future. In economics, the main function of a currency is that it is a "store of purchasing power", means if you had $100 bill last year you should have been able to buy the same thing with that bill today as you would last year, that is if the value of the currency is stable. In the case of the dollar, inflation resulting from low interest rates, destroys any incentive to save (well I mean save in dollars) and pushes people to consume and borrow (therefore spend more than they can earn). The only solution for someone who want to save (who has extra stocks) is to hoard it (that is keep it in its original form) and not convert it into dollars (that saving will lose you money). Keeping oil in the ground will save its value because value is intrinsic to physical products or services and money is not equivalent to value/wealth which can and do lose value.

So yes, this is true without even mentioning the other reason why people are interested in hoarding (driving down supplies to a level very close to demand keeps prices enough so that demand is not fully destroyed - and Revenues = Price x Quantity will remain high (increasing price beyond a certain point is not beneficial for OPEC because at that time quantity demanded will decrease more proportionally (people cannot afford it) and Revenues will go down).

EDIT: efflandt, what you are saying is true but this is not what the article is talking about.

Answer 3

The oil producers are happy making lots of money and want to sustain that for a long time.  What incentive would there be for them to create a surplus of oil, drive the price down, and use up their resources sooner?  Those resources could fetch a higher price later.

Answer 4

It doesn't make sense to argue that by "keeping the US dollar interest rate below the inflation rate will most likely cause a decrease in oil production."

A low US Dollar (USD) does not drive oil prices down it has the OPPOSITE  effect.

http://www.iht.com/articles/2008/07/01/b...

Take a look at this chart (center page).

http://www.econbrowser.com/archives/2007...

Chart shows from 1975-2005 that the US Dollar has an inverse relationship to oil prices.

The USD and inflation are completely two different things. One cannot make a currency valued below inflation. That argument just doesn't make any sense.

example. US Inflation is running about +/-5%. How does one value the USD at 4%? Currency is not valued in percent terms, so I have to disagree with the article in this area.

Low US interest rates devalue the USD, and drive all commodities that are priced in dollars such as oil and grains higher in value.

The US FED wants to raise interests like a teenager wants to have his first sexual experience. The problem is that raising US rates will kill the fragile US housing market, impact banks, and mortgages. It would have a negative global impact.

I would listen to professional oil traders (15+ years in the business) than the media.

I have had many posts that discuss oil prices in great detail. My posts are private. You have to add me to read my posts.