Probable FOMC Interest Rate Hike(s) in 2016: Underestimated Headwinds for WTI?

This article is also available at my LinkedIn page.

Generally, I am of the belief that as production is being curtailed in America and globally, eventually the market slack will tighten and the demand will begin to outpace the speed with which producers can get certain wells online. To be sure, there are many DUCs in various shale plays ready to roll (drilled but uncompleted wells), but I still believe that the oil and gas “illiterati” is failing to account for production curves – the sharp decline in a horizontal well’s rate of production after a few years. Yes, the costs are sunk once a well is drilled, but the notion that these shale wells will maintain their early pace in perpetuity is misguided. But that’s a different topic.

Something I’ve noticed more recently, but which doesn’t seem to be getting a lot of attention at least in terms of those whom I talk to regularly, is the interplay between 1) WTI pricing, and 2) the relative strength of the U.S. Dollar versus other foreign benchmark currencies (China’s yuan, Russia’s ruble, et cetera). The Bank of Japan recently unveiled a negative forward interest rate related to certain instruments, as did the European Central Bank. Meanwhile, the Federal Open Market Committee, the governing arm of our Federal Reserve, attempted to lift off from a zero percent interest rate that has been in place since the “Great Recession” several years ago; however, global financial issues are injecting uncertainty into how strong the global economy actually is, and whether the United States can march upward headstrong without considering the consequences in a globalized world.

It currently appears that the FOMC will at least be tapping the brakes in 2016 from what it had originally planned in terms of raising interest rates several times. At this point, many market prognosticators seem to land at there being a potential for anywhere between zero to two hikes. Any hikes may weigh against WTI crude oil pricing: since WTI is priced in dollars, and interest rate hikes make a country’s currency stronger relative to other currencies, it would make WTI cheaper in other currencies, thereby reducing the relative sale price of the crude oil in dollar terms. Combine these potential rate hikes here with many institutions charged with managing currencies actually going down to zero percent interest rates, or even negative rates, and that has a multiplicative effect on this headwind.

Ultimately, I wouldn’t forecast this situation as a great potential weight depressing WTI prices going forward, but it will apply some downward pressure to such prices for as long as this interest rate disparity between the United States and other countries continues. At this point, this is probably more of a footnote to the supply vs. demand issue we are currently working through, but still a worthy topic of discussion to understand how global markets can influence what a barrel of West Texas Intermediate crude oil can sell for.

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