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What the Fed’s Interest Rate Hike Means for Oil Prices

by | published June 16th, 2017

Finally, after almost a decade of historically low interest rates, the Fed is removing the proverbial punchbowl from the easy-money party.

As it stands, Yellen & Company are only moving rates a mere 0.25% each time – most recently this past Wednesday, for the second time this year.

That’s great news for anyone looking for investment income.

But unfortunately, it also means projections of doom and dread for oil prices are now running rampant.

These talking heads would have you believe that the sky is once again about to fall, because higher interest rates are supposedly dire news for oil prices.

Here’s why they’re wrong…

The Irrational Frenzy Surrounding the Fed’s Decision

While the actual 0.25% is nothing major, and was already factored in by bond markets, there is the emotional reaction to the Fed’s decision.

Especially in the oil market, which is already jittery.

The presumption is that interest rate rises put immediate pressure on crude prices by making purchases more expensive in foreign markets.

This is because a rise in rates results in dollar-denominated bonds becoming more attractive, thereby increasing the exchange value of dollars against other currencies.

And that’s what will have the greatest initial impact on oil.

Because the vast majority of oil sales worldwide are denominated in dollars, a rise in the dollar means it costs more in other currencies to buy a barrel of oil.

Conventional “wisdom” holds that this has an adverse impact on demand. All other things being equal, there may be a change, even if short-lived.

Demand, Not Interest Rates, Will Determine Long-Term Energy Prices

However, the real effect on demand centers on what impact the rise in both the price of oil and the exchange value of the dollar will have on a range of economic matters.

In this respect, the broader usage of energy (beyond simply that of oil) will be at issue.

Market demand for all manner of energy will ultimately be determined by genuine demand, not by stimulated usage from lower prices.

After all, almost without exception, depressed prices (such as we’ve experienced in spades recently) tend to increase the use of energy. And as energy becomes cheaper, end users increase consumption.

But the real impact will be felt across a broader range of commodities – metals, processed products, natural gas, even electricity traveling across borders.

Yet in all, this will be quite manageable, with the negative impact of interest rises greatly overestimated.

What will take a bigger hit are the artificial pressures that have been distorting the actual market rates for oil. Here the hyped short selling and multiplication of derivatives through which manipulators have artificially made profits from a crude dive will be distorted.

That bubble will be more pronounced, but that is going to be a problem primarily for those who created it.

That’s karma for you.

But here’s what you need to remember…

Oil Markets are Returning to Balance, Whatever the Fed Does

Energy demand elements are emerging that far outweigh the significance of any Fed move.

Because while the fixation on a rise in interest rates continues, aggregate expected global oil demand is moving up regardless.

The International Energy Agency (IEA) expects global oil demand to grow by 1.3 million barrels a day in 2017, with increasing vehicle sales and air travel in China set to overcome any fears of a slowdown there.

Meanwhile, the OPEC oil cartel has extended its oil production cuts by nine months, into early 2018.

So regardless of what the Fed does or doesn’t do, the fundamentals paint a picture of tightening oil supply at a time of increasing demand.

That will be where the real long-term pricing of oil is going to be determined. Because as long as the world demands energy – and those demands are increasing – the energy sector will prosper.

And we’ll find ways to make money.

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