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Analysts see oil rising if US defaults on debt

By Chris Kahn

Associated Press

Published: Monday, July 25 2011 2:14 p.m. MDT

NEW YORK — If the U.S. defaults on its debt, it would send shockwaves through oil markets that could push fuel prices higher, analysts said Monday.

Experts disagree about how much oil prices will respond if lawmakers fail to raise the nation's debt ceiling by an Aug. 2 deadline. What's clear is that a default would sink the value of the dollar. When that happens, oil almost always goes up.

"If there's a default, everyone is going to be dumping dollars," said Rice University professor Ken Medlock, who has studied the historic relationship between oil and the dollar. "You should see massive inflation" for any commodity priced in dollars. That includes oil.

Oil was down slightly Monday with eight days left before the deadline. Analysts say they're still confident that Congress will not allow the nation to default, but oil investors could still hedge their bets and begin pricing in the possibility of a default by the end of the week.

Benchmark West Texas Intermediate crude for September delivery on Monday lost 67 cents to settle at $99.20 per barrel on the New York Mercantile Exchange. In London, Brent crude fell 73 cents to settle at $117.94 per barrel on the ICE Futures exchange.

Oil and the dollar have been intertwined since 2000, Medlock said. When the dollar falls, oil almost always rises. Crude is priced in dollars. When the dollar falls, investors holding foreign money can buy oil more cheaply. That sparks demand for oil, and increased demand pushes prices higher. A weaker dollar also means oil producers like Saudi Arabia will earn less for every barrel of oil they sell. Oil prices tend to rise when this happens because traders expect OPEC and other countries to cut production in response.

When the dollar falls, investors turn to commodities and stocks. The effect was apparent in early May. The U.S. Dollar Index, which tracks the greenback versus other major currencies, dropped to its lowest level of the year. At the same time, oil prices rose above $113 per barrel, the highest level since 2008.

It's hard for analysts to say just how much a U.S. default would affect oil. Independent oil analyst Andrew Lipow thinks a U.S. default could mean a plunge in oil markets — at least at first. The U.S. is the world's largest petroleum consumer, and if it can't pay its bills, demand for petroleum will surely fall, he said.

PFGBest analyst Phil Flynn agreed. He expects the rise in oil would come later as the dollar's influence eventually weighs on oil markets. Prices will rise, heaping extra pressure on the economy by making gasoline, jet fuel, diesel and other fuels more expensive. After slipping to about $90 per barrel, post-default oil prices could eventually rebound to between $120 and $130 per barrel, Flynn said.

"You'll see a rush to commodities as well as emerging markets" like China and India, he said. "And guess what the emerging markets do when they get money — they buy oil."

In other Nymex trading for August contracts, heating oil lost 2.08 cents to settle at $3.1207 per gallon and gasoline futures gave up less than a penny to settle at $3.0817 per gallon. Natural gas lost 1.5 cents to settle at $4.355 per 1,000 cubic feet.

Chris Kahn can be reached at www.twitter.com/ChrisKahnAP .

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