Even though the price of a barrel of Brent crude oil has been hovering at the $82 per barrel (bbl) mark, up from the $78/bbl average for December last year, it is still a far cry from the $94/bbl of September. The ongoing geopolitical tensions in the Middle East, a record output from the United States, and the effects of the OPEC+ committee extending oil production cuts into next year are all contributing to the oil price’s volatility.
The Gulf region has some of the largest oil reserves in the world. Oil exports constitute a significant portion of their GDP, government budgets, and trade balances, making them highly sensitive to oil price changes. At the start of 2024, economists polled by Reuters estimated that the GCC economies will grow at a faster pace despite weak global economic growth.
It therefore stands to reason that higher oil prices will increase government revenues to enable increased spending on infrastructure, social programs, and economic diversification initiatives. Furthermore, higher oil prices improve the trade balance by increasing the value of oil exports. Adding complexity to the oil price volatility is the currency market. Even though the Saudi Riyal (SAR) and UAE Dirham (AED) are pegged to the US dollar, oil price fluctuations can still affect their value indirectly. For instance, higher oil prices can strengthen these currencies by improving economic stability and attracting foreign investment.
Impact on Forex markets
In practice, there are very real direct and indirect links between oil prices and currency markets. From a direct perspective, oil-exporting countries across the Gulf see their currencies strengthen with rising oil prices. Indirectly, oil prices impact inflation and interest rates. Around the world, higher oil prices can lead to higher inflation, prompting central banks to raise interest rates. In turn, this can strengthen currencies across the Gulf. On the flip side, lower oil prices can reduce inflationary pressures and contribute to the likelihood of lower interest rates.
“Traders can therefore take advantage of oil price movements by closely monitoring commodity-linked currencies and other economic indicators”
Because the Brent crude contract is quoted in US dollars, any pricing change will impact all the related crosses. In the past, the Canadian Dollar (CAD) and the Norwegian Krone (NOK) have proven good barometers for how oil prices impact currencies with the former strengthening in 2014 due to increased oil export revenues, and the latter weakening significantly when oil prices plummeted due to the pandemic.
Strategic responses
Traders can therefore take advantage of oil price movements by closely monitoring commodity-linked currencies and other economic indicators. Currency pairs like the USD and CAD, and the Euro and NOK are highly sensitive to oil price changes. By using forex options and futures, traders can potentially hedge against unfavourable currency movements due to oil price volatility. For instance, traders can buy options to protect against potential losses if oil prices drop.
Keeping a finger on the pulse
Other factors impacting the oil price fluctuations and forex markets include the ongoing Russia-Ukraine conflict and changing global energy demand with sustainability becoming an increasingly important decision around power generation and the materials used to do so. These are particularly relevant when conflicts take place in oil-producing regions with shifts in energy policies exacerbating changes in oil prices. Traders must therefore expand their monitoring net to include these developments if they are to make informed decisions on investments.
Managing risks
It is, therefore, evident that oil price volatility significantly impacts forex trading, especially in the Gulf region which has significant oil-exporting production. Successful trading in this market is therefore reliant on having a good understanding of the relationship between oil prices and forex markets. By recognizing the economic interdependencies and potential risks, traders can optimise their strategies and mitigate potential risks.
