FX: How commodity-linked currencies will fare on the path to net zero
As COP26 winds up, Euromoney looks at how a big reduction in fossil-fuel consumption might impact the currencies of the world’s leading coal and oil exporters.
The currencies of countries with substantial energy reserves have always been vulnerable to falling commodity prices. For example, the weakening of crude-oil prices towards the end of 2018 led to a double-digit drop in the value of the Canadian dollar.
Conversely, free-floating commodity-linked currencies do well when demand – and prices – are strong, a scenario that has seen the Canadian dollar become one of the best-performing currencies of 2021.
To date, the health of commodity-linked currencies has largely depended on market forces, but as the world moves – albeit slowly and patchily – towards decarbonization, the link between economic activity and fossil-fuel consumption will inevitably weaken.
Research published by Nature Energy earlier this month suggested that net-zero policies could leave up to $11 trillion of fossil-fuel assets in effect worthless or “stranded”. However, Naeem Aslam, chief market analyst at FX broker AvaTrade, reckons we are still a long way from the moment when a notable reduction in emission targets will have an impact on currencies.
“We don’t envisage any significant influence in the near term and, more importantly, countries are already diversifying their operations towards renewable energy,” he says. “So, the end-effect is likely to be relatively minor.”
This year’s events show that we will still see a new commodity supercycle before the final decline of fossil energy
The Nature Energy research also suggested that while the economies of the US and Canada would contract by 2036 as a result of the fall in the value of their fossil-fuel assets, Russia, Saudi Arabia and Australia would see an increase in GDP.
Craig Erlam, senior market analyst UK & EMEA at Oanda – an FX trading and broking house – agrees that the time horizon for net zero is so long that countries have plenty of opportunity to reduce their dependence on commodities.
“That is not to say that some currencies won’t be worse off, but it will be easier to judge over time as it will be those that fight rather than embrace the change [that perform the worst],” he says.
The difficulty in evaluating the environmental element of currency valuation is that it requires consideration of a number of factors, explains Kit Juckes, chief global foreign exchange strategist at Societe Generale.
“If we look at the Norwegian krone, for example, Norway sells a lot of oil and gas, but also has a substantial domestic renewable-energy industry that would earn huge points on any environmental measure,” he says.
A ban on coal production and use would clearly affect the Australian economy heavily and reduced oil consumption would likewise impact Saudi Arabia, so market analysts would want to know what the plan is for when the commodity runs out or is no longer valuable.
Currencies of some of the large energy producers have come under pressure this year, with the Australian dollar losing more than 8% of its value against USD on the back of China’s refusal to clear Australian coal. But the world is also not ready to give up fossil fuels as quickly as China has tried to do this year.
That is the view of Alex Kuptsikevich, senior financial analyst at FxPro, who says only very long-term plans to reduce the use of fossil fuels should be taken seriously.
“The impact on currencies would then be difficult to separate from other factors, such as balance of payments and monetary policy,” he says. “This means that it would be hasty to bet against RUB, AUD or CAD right now. This year’s events show that we will still see a new commodity supercycle before the final decline of fossil energy.”
It is also worth considering that coal and oil are not the only exports for leading commodity producers and that switching to alternative energy sources will translate into higher demand for other commodities.
For example, growing use of electric vehicles will boost demand for lithium, which is found in large quantities in the US and Australia. “Meanwhile, northern European countries could benefit from increased energy exports to central Europe as wind power is ramped up,” adds Kuptsikevich.
According to Peter Rosenstreich, head of investment products at Swissquote, the move to renewable energy will not only have the effect of benefiting leading oil and coal importers by reducing external capital flows and potential political entanglements with countries they would rather not do business with.
“The significant reduction in the use of ‘petrodollars’ (oil is almost always traded in USD) will also negatively drag USD,” he concludes. “Recycled dollars are used to purchase US securities, which helps keep interest rates low and growth high.
“This would be a meaningful step towards ending the US dollar’s role as the global reserve currency.”