For the dollar, US energy boom is good, but no bonanza

NEW YORK: Investors looking for the boom in US domestic energy production to boost the US dollar might have to settle for a more modest impact.
Rapid increases in US production of oil and natural gas from shale formations has provided a cheap source of energy for utilities and manufacturing and drastically cut US dependence on foreign energy sources. US imports of foreign crude oil fell last year to their lowest since 1997 as domestic production rose to the highest level since 1995.
This is helping to reduce the US trade deficit, which has been a drag on the greenback. And it could eventually even help to curb the nation’s budget deficit, which is also a negative for the currency, if the energy bonanza leads to higher economic growth and higher tax revenues.
But the United States will continue to depend in part on imports in the medium-term, reducing the impact of the production boost. In addition, with the way aggressive central bank activity dominates sentiment right now, the dollar is facing other factors.
"It's a positive, but not the game changer some are expecting," said Axel Merk, chief investment officer at Merk Funds in Palo Alto, California, who oversees $ 630 million in assets. "The US still needs to find its way back onto a sound footing,” he added in reference to the large entitlement programs that make up the bulk of the nation's debt problems.
Instead, the dollar is much more likely to be buffeted by the policies of the US Federal Reserve and other central banks around the world, and whether growth in the United States and elsewhere begins to pick up again.
Fears that central banks and governments will get into a “beggar thy neighbor” fight by debasing their currencies to try to boost their own exports and growth is a particular worry, which could boost the dollar.
If the Fed pulls back from the third phase of its stimulus program, known as quantitative easing, it would likely lead to higher interest rates (a positive for the dollar), but could hurt growth (a negative).
“US energy independence will be good for the American economy, but largely irrelevant for the dollar," said Joseph Trevisani, chief market strategist at WorldWideMarkets in Woodcliff Lake, New Jersey. "Strength and weakness in the dollar is largely determined by central bank policy and only to the degree that the economy pushed interest rates higher will the dollar be affected at all."
US energy infrastructure has yet to catch up with the production revolution. Refiners on the coasts will continue to need to import some oil in part because of the difficulty of getting oil from the middle of the country to those areas.
In favor of the improved trade deficit is this: Refiners in the Gulf Coast and Texas have been able to export more US oil products such as diesel fuel elsewhere, which leads to the buying and selling of dollars.
An improved outlook for manufacturing thanks to cheap energy could improve fund flows into the United States as foreign investors establish plants or buy American companies, or just invest in the US stock market.
A look at the US dollar index, a broad measure of the dollar's value against several currencies — the yen, euro, pound, Canadian dollar, Swiss franc and Swedish krona — does not show a clear correlation with changes in the trade deficit in recent years.
The US trade deficit reached its narrowest point in nearly three years at $ 38.5 billion last December, the Commerce Department said on Feb. 8. Yet, the dollar index last traded at 82.26, which is 16 percent above a low of 70.70 reached in March 2008.
When the US dollar index peaked in July 2001 around 121, the trade deficit was not so different, sitting at $ 30.09 billion. And when the trade deficit was widest at $ 67.351 billion in August 2006 the dollar index was close to Monday’s level of around 84.
If major world central banks start to remove stimulus as the world economy improves, factors such as energy independence could have a more pronounced effect, but that day is far away.
"This will happen over a very long time frame, not months but years," said Dean Popplewell, chief currency strategist at OANDA in Toronto. And "there are a lot of substantial road blocks ahead."
Researchers at Citigroup said in February that greater US production, less consumption and fewer imports could reduce the current account deficit by up to 2.4 percent of gross domestic product. That could produce an associated improvement in the US dollar of between 1.6 percent and 5.4 percent, they forecast.
The effects would be gradual, however, as the report looks out to 2020.
Refiners in the United States purchased a bit less than 8.5 million barrels per day of foreign oil in 2012, down 440,000 from 2011, according to the US Energy Information
Administration. It was the sixth decline in seven years.
The drop in imports came as demand declined and US crude oil production shot up to an average of nearly 6.5 million barrels a day, the highest since 1995. By December, daily US production topped 7 million barrels, the highest monthly level since 1992, according to the EIA.
Still, the dollar index fell 0.5 percent in 2012, even as this improvement was taking place. A shift for sure, but hardly seismic.