Fed rate cuts boost oil futures prices

By Tom Stundza -- Purchasing, 3/19/2008 11:07:00 AM

Crude oil prices headed higher to $109 for April delivery on the New York Mercantile Exchange this week after the Federal Reserve cut interest rates three-quarters of a percentage point and a rally on Wall Street raised energy investors' hopes for further price hikes. In the past several months, rate cuts have fed oil price rallies as investors bought crude futures to hedge against inflation and the falling dollar.

Also, oil futures are priced in dollars, which makes them cheaper for foreign investors as the greenback falls. "The Fed continues its eight-month trend of loosening credit which will, in turn, continue the downtrend in the value of the dollar,” says Larry G. Chorn, chief economist for Platts in an Associated Press report. "If recent history is a guide, the 75-basis-point rate reduction by the Fed could result in oil prices rising to the $112 to $115 range over the course of the next weeks.”

The Fed has now cut rates by three percentage points since mid-September, including two points this year, with the benchmark rate now 2.25%. Upshot: “Oil has become the ‘new gold,’ a financial asset in which investors seek refuge as inflation rises and the dollar weakens,” says Daniel Yergin, chairman of Cambridge Energy Research Associates in a new report. “The credit crisis has been fueling the flight to oil and other commodities, and that will last until the dollar strengthens or the recession becomes more pronounced.”

“Today, the falling demand for dollars is just as important as the rising demand for oil in determining the oil price,” says Yergin. “However, when looking back to 1980, today's high prices also have a ‘back to the future’ quality. Many similar elements that have contributed to the rise in price from $70 last summer to over $100 today were also in play in 1980: high inflation, a rush by financial markets to invest in commodities -- gold's all-time high was in 1980 -- and tension between the United States and Iran.”