Oil Momentum Shaken as Dollar Link Questioned, Eye on Demand

HOUSTON, May 02, 2008 (Dow Jones Commodities News)

Oil futures appear to be taking their cue from strong global demand after entering a period of uncertainty on a newly resilient dollar.

Benchmark crude futures this week have traded as high as $119.93 a barrel and as low as $110.30 on the New York Mercantile Exchange, an unusually wide trading range even at the current near-record prices. The price swings - capped by a $3 rise on Friday - reflected fundamental swings in the energy and financial worlds, including massive oil production outages early in the week and a potential new course of action by the Federal Reserve that sent the dollar soaring against the euro.

With some of that oil coming back online after the resolution of problems in the North Sea and Nigeria, traders turned their focus to the dollar for signs of where oil is headed next. After a three-month rally based largely on the dollar's steady weakening, the market is seeking to establish its near-term outlook as the currency begins to strengthen.

"I don't think this market knows what it wants to do right now," said Peter Beutel, president of trading advisory firm Cameron Hanover. "Right now it's going through a number of sea changes in things like the dollar and the Fed's stance."

Oil market participants said crude may start to take its cue more from signs of strength in U.S. economic data, while strong global demand - most notably in China - could limit any major selling.

"It's back to demand," said Mark Waggoner, president of Excel Futures in Huntington Beach, Calif. "One of the reasons the dollar is going up is (the belief that) the recession is limited, and if the recession is limited, then demand will stay up for reformulated gasoline."

The Federal Reserve cut its benchmark interest rate by a quarter point on Tuesday, then signaled that it may hold off on further reductions. For months money flowed into energy markets as investors sought insulation against the weakening dollar and the forces of inflation, and appeared to be following the reverse path as the U.S. currency strengthened rapidly on the Fed's statement.

As Friday's trading showed, the greenback isn't always the most reliable indicator. Although the euro hit its weakest point against the dollar since March 24 - at $1.5360 - oil soared by more than 3% and settled $6 above the low hit Thursday.

Higher Next Week

Indeed, the factors supporting the dollar - signs of stability in the U.S. economy evident most recently in a much stronger-than-expected April non-farm payrolls report - may help support oil prices also. A stronger U.S. economy would indicate growing demand from the world's largest consumer of oil, though few were willing to bet on a full recovery based solely on the April payroll data.

The notion that oil prices only came within shouting distance of $120 a barrel because of a weak dollar - the euro was trading at $1.60 a little over a week ago - has long been a subject of debate. While the currency has certainly played a role in pushing oil prices higher, analysts also point to fundamental forces of demand globally that keep prices near record territory.

The rally on Friday "should show that there is no overarching reason to think that oil has turned the corner and a full-blown reversal is underway," wrote John Kilduff, vice-president for energy risk management at MF Global. "Demand that may be contracting in the U.S. is more than being offset by demand from China, India, and the Middle East."

Beutel, at Cameron Hanover, sees oil prices coming close to record levels, and potentially setting new highs next week. Although the Fed's apparent reluctance to cut interest rates further should cause the dollar to strengthen, others will see the pause as a sign that the economy is strengthening, he said.

Eyeing New Highs

Uncertainty about the Fed's next course of action could break apart the relationship between oil and the dollar, which would leave crude's near-term fate under the influence of sentiment about the strength of the U.S. economy and geopolitical tensions, said Matt Zeman, head of trading at LaSalle Futures Group in Chicago.

A weaker dollar makes it more attractive for investors in other currencies to buy dollar-denominated crude.

"I don't think people are going to continue to buy crude oil based on what the dollar's doing," he said.

Next week, that's likely to mean yet more record highs for oil futures, as the market processes the April payroll data and other relatively positive economic indicators released over the last few days, Zeman said.

Copyright (c) 2008 Dow Jones & Company, Inc.