Oil Price "Locomotive" to Pull Canadian Dollar Higher say Analysts

- GBP/CAD rally blunted by oil price rise
- "Go long" Brent says OCBC
- Analysts see robust oil prices going forward

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The oil market is in an uptrend and there is little to stop its appreciation until Brent hits at least $70/ barrel according to one analyst we follow, a development that bodes well for the Canadian Dollar and other oil-linked currencies.

Brent crude and other global oil benchmarks have been climbing since April 2020 when investors started to look through the covid pandemic towards a global economic recovery, increasing the foreign exchange earnings potential of the world's major oil exporting countries.

Although there was something of a dip in the market in August-November of 2020 the trend has resumed with vigour into 2021, and currency markets are responding.

"Recent oil price developments support our bullish outlook for oil-related currencies this year," says Derek Halpenny, Head of Research, Global Markets EMEA and International Securities at MUFG.

Above: The price of Brent crude has been steadily rising.

"The performance of oil-related currencies have become more tightly correlated with the price of oil in recent months," he adds.

Halpenny says the performance of the specific type of oil Canada produces has been particularly notable, given it has risen faster than the global WTI and Brent benchmarks.

"Price action for Western Canada Select crude oil has been even more bullish rising to its highest levels since September 2019," says Halpenny.

The Pound-to-Canadian Dollar exchange rate had risen from a low of 1.6769 on December 11 to peak at 1.7641 on January 29, but the ascent by the Pound has stalled and the pair has since reversed back to 1.7527.

The recent decline does coincide with a pickup in oil prices and the Canadian Dollar:

Above: The rally in West Canada Select crude oil prices.

Analysts say happens to oil prices going forward could well impact on the Canadian Dollar outlook.

MUFG says oil prices should continue rising over coming months, an observation that keeps them bullish on the Canadian Dollar's prospects.

MUFG's oil analysts say the sheer velocity of the leg up in oil prices since the turn of the year compels them to not rule out Brent reaching USD70/barrel this year.

They expects the price of oil to continue to be supported by the rising level of demand.

"We maintain a bullish outlook for oil-related FX. If the price of oil continues to rise or remains at higher levels, it should encourage stronger currencies," says Halpenny.

George Vessey, UK Currency Strategist at Western Union tells clients to keep an eye on oil-linked currencies, given the rally in the oil price of late.

"Oil prices climbed last week and remain elevated," says Vessey, adding some of the lift in oil prices over recent days can be attributed to comments from OPEC countries about cutting supply.

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"The improving economic outlook and hopes for further U.S. economic stimulus to boost crude demand is also supporting the price lift," he says, adding:

"Currencies that often correlate with commodity prices such as AUD, NZD, ZAR will be watched closely, but particularly those currencies of countries that export oil, such as NOK, RUB and CAD."

Saudi Arabia said on January 05 they would reduce oil output by an extra 1 million barrels a day in February and March even as Russia moves to increase production, in a bid to keep the Opec+ group’s fragile alliance intact in the face of the coronavirus pandemic.

The Kingdom meanwhile last week defied market expectations of a 15% cut to its OSP, choosing to stand pat on its $1 premium pricing of its Arab Light crude.

"With Saudi Arabia pledging extra supply cuts over the next couple of months, it’s unlikely oil prices will fall substantially any time soon, which means commodity currencies could continue climbing higher," says Vessey.

Another major oil-linked currency to watch is the Norwegian Krone, which has also come back strongly over recent days in tandem with rising oil prices.

"Despite the strong start to the year, GBP/NOK is back on the defensive because of the rallying oil prices after suffering its biggest daily decline of 2021 last Friday," says Vessey.

Developments in GBP/NOK could serve as a warning of the potential for a decline in GBP/CAD should oil prices continue their ascent.

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Commodity analysts at OCBC in Singapore say there is "no stopping the crude oil locomotive" and they are looking for the appreciation in oil prices to extend, saying in a weekly research note that are tactically "long" on the price of Brent crude.

"Brent is unlikely to rest until it sees $60/bbl, or more," says Howie Lee, Economist at OCBC. "The upward trend remains intact, well supported by Saudi’s supply policies and the market’s eagerness to overlook short-term demand weakness."

In addition to Saudi Arabia's actions, U.S. crude oil inventories continue to fall and Asian crack margins continue to climb.

"There is little to stop the crude oil locomotive at the moment. Any pull back in prices is likely temporary and shallow. We stay long the energy complex," says Lee.