What should OPEC do?

[RichardR]

So you agree that following a $US depreciation, every non-dollar buyer will get oil cheaper if the Dollar depreciates. That will create excess demand at the prevailing Dollar denominated price. From Econ 101, excess demand leads to rising prices (in Dollars), until a new equilibrium is reached at a higher Dollar price. QED.

OK, I accept that a falling dollar would mean oil was cheaper elsewhere, and this would increase demand. However I question how much this increase would be. For example, in Europe the price of oil is typically only 25% of what the consumer pays – 75% is tax. A 25% reduction in the cost of oil would therefore only represent less than a 7% drop in prices. And even then, surely a proportion of consumption is virtually fixed (in the short term anyway): some journeys are necessary / industry uses the power it needs for the level of economic activity prevailing.

I don't see how, as the dollar falls, the price of oil would automatically rise at the same rate the dollar falls. Wouldn't it rise by only a fraction of that?

 

[Drooper]

OK, I accept that a falling dollar would mean oil was cheaper elsewhere, and this would increase demand. However I question how much this increase would be. For example, in Europe the price of oil is typically only 25% of what the consumer pays – 75% is tax. A 25% reduction in the cost of oil would therefore only represent less than a 7% drop in prices. And even then, surely a proportion of consumption is virtually fixed (in the short term anyway): some journeys are necessary / industry uses the power it needs for the level of economic activity prevailing.

I don't see how, as the dollar falls, the price of oil would automatically rise at the same rate the dollar falls. Wouldn't it rise by only a fraction of that?

You are right. There wouyldn't be a one-for-one inverse relationship. I am sure i you do a journal search you will find some work on this. I would reckon, as a ball park estimate, that about 70-80% would transmit through to the Dollar price.


Just keep telling yourself "the Dollar is just the numeraire. The $US isn't the real price, just the representation of the price expressed in terms of one particular currency unit.