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Foreign Exchange

Fracking brilliant: energy innovation set to boost dollar

The dollar’s long-term outlook will be greatly aided 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 suggested the energy industry’s new fracking drilling technique, which uses jets of water to unlock trapped gas, might allow America to increase commercially available gas reserves by a factor of 10.

US Gas reserves could match those of the Middle East
 Source: UBS
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 America were able to dramatically increase its gas reserves, then it could substitute domestic gas supplies for foreign oil imports – particularly from volatile regions such as the Middle East.

As the US net oil import position accounts for the majority of America’s external imbalances, 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 so-called petrodollars.

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

Oil imports account for a large portion
of US current account deficit
 
 Source: UBS

The Abu Dhabi Investment Authority (ADIA), the largest sovereign wealth fund in the world, has said its maximum benchmark for investing in North American assets is only 50% of its overall portfolio, while its minimum benchmark is as low as 35%. 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.

Therefore, 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.

Dollar's correlation with Oil prices to break

Over the last ten years the dollar has displayed a negative correlation with oil prices as increased energy costs widen America's current account deficit and lead to inflows into dollar-diversifying sovereign wealth funds. 

"However if American's net energy position improves significantly with the commerical exploitation of shale gas, investors should not expect oil prices to remain negatively correlated to the dollar,” concluded Mohi-Uddin.

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