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Foreign exchange: Fracking will boost dollar

Gas exploitation set to reduce US deficit; SWFs will have less influence on dollar’s value

The dollar’s long-term outlook might be greatly enhanced by lower reliance on Middle East energy, which will reduce the current account deficit that has long been a drag on the currency.

Research from UBS suggests that the energy industry’s new fracking drilling technique, which uses jets of water to unlock trapped gas, might enable the US to increase commercially available shale gas reserves by a factor of 10.

That would bring US energy reserves relative to current production in line with Middle East countries such as Qatar, which has gas reserves of well over 100 years at current production rates.

If the US were able to increase its gas reserves in this way, it could substitute domestic gas supplies for foreign oil imports – particularly from volatile regions such as the Middle East.

“If America’s net energy position improves significantly with the commercial exploitation of shale gas, the dollar is likely to break its relationship with oil”

Mansoor Mohi-Uddin, UBS

As the US net oil import position accounts for most of the external imbalances of the US, less reliance on foreign oil supplies would lead to a sharp improvement in its current account deficit. "Reducing the US current account deficit from 3% of GDP to lower levels or even into a surplus would provide a major boost to the dollar over the next decade," says Mansoor Mohi-Uddin, head of FX strategy at UBS.

Furthermore, if US oil imports from the Middle East fall, so too will the growth of the region’s sovereign wealth funds as they accumulate fewer petrodollars.

That is likely to have a huge effect on the dollar, as Middle Eastern sovereign fund managers tend to diversify their portfolios by converting dollars into other currencies.

The Abu Dhabi Investment Authority (Adia), the world’s largest sovereign wealth fund, has said its maximum benchmark for investing in North American assets is just 50% of its overall portfolio.

So for every petrodollar of revenues Adia initially accrues from Abu Dhabi’s energy exports, more than half is likely to be diversified out of the dollar.

If the US is able to commercially exploit vast newly available gas reserves, the dollar’s long-term outlook looks set to be greatly aided by a lower US current account deficit and by sovereign wealth funds accumulating fewer dollars to sell for other foreign currencies.

Over the past 10 years the dollar has displayed a negative correlation with oil prices as increased energy costs widen the US current account deficit and lead to inflows into sovereign wealth funds that then diversify out of dollars into foreign assets.

"However if America’s net energy position improves significantly with the commercial exploitation of shale gas, the dollar is likely to break its relationship with oil," says Mohi-Uddin.

US current and oil account 
US external balances  
Gas reserves
Source: UBS FX Strategy

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