Rising Gas Prices and the Value of the Dollar

This morning I caught the following stories and I wanted to make a quick comment regarding their interconnection.

Oil Hits High; some in US see $4/gallon gas by spring

Euro Soars to Record High, $1.5057

Ignoring the fact that we pay about $4/gallon for gas here in Ukraine, I find it interesting how these facts are reported and that few people point out the link between these 2 news events.

The first story is fairly informative, pointing out that much of the increase in oil price stems not from a decreasing supply of oil but rather a massive increase in the usage and industrialization as Asia continues its development.  It also points out that although the actual price is at an all-time high, adjusted for inflation, we are still not paying as much as during the price control era of the 70's and early 80's - let this be a lesson to us.  

What is rarely mentioned about increases in per barrel oil prices is that they are connected to the fluctuating value of the US dollar.

This is a fairly simple concept but not one that the average person would decipher on their own.  First, oil is bought and sold in USD largely out of the middle east.  Let's imagine a sheik in Dubai wants a solid silver-bodied Audi A8 (I know some do; I've seen pictures), it may cost him 10 million Euros (because Europe is where Audis come from).  To do this, he must sell 10 million Euros worth of oil.  Unfortunately for him, he sells his oil in USD which aren't accepted at the Silver-bodied Audi dealership so he must exchange them for Euros.  If the exchange rate is $1.25 per 1 Euro, then he needs to sell $12.5 million in oil to fill his piggy bank (or, since he is likely Muslim, goaty bank).  At $80 per barrel of crude, this comes out to 156,250 barrels of oil: that is what his silver-bodied Audi A8 is worth to him.

Now let's take our same sheik and put him in a world - our world, coincidently - where the exchange rate has gone to $1.5057 to the Euro.  Now he must sell $15,057,000 worth of oil to buy his Audi, but with global demand for oil very high, he is in a position of power.  He tells his buyer that the same 156,250 barrels of oil (the price of his Audi) are now worth $15.057 million.  Do the math and now a barrel of oil costs $96.37; a 20% price increase with no real change in production, supply, demand or anything else directly related to oil.  Further, the sheik himself, while selfish for buying a silver Audi that he'll never drive, isn't actually taking in any more money than when oil was $80/barrel.  His life runs on Euros, of which he still makes 10 million.

So if we want to blame someone for high oil prices, maybe we should look at all the jokers in the US who bought more house than they could afford, foreclosed and are currently driving our economy (and thus our exchange rate) into the ground.

By way of disclaimer, most of the above numbers and maybe some of the facts are greatly simplified or completely fabricated.