October 2011, 30th USAEE/IAEE North American Conference

1. October 2011, 30th USAEE/IAEE North American Conference Oil Price and Exchange Rates: A New Perspective H. Audigé, Banque de France, henri.audige@banque-france.fr E. Hache, IFP-School, emmanuel.hache@ifpen.fr A. Pierru, IFP EN, axel.pierru@ifpen.fr The research and Views expressed in this paper are those of the individual researcher and do not necessarily represent the views of the IFP October 2011, 30th USAEE/IAEE North American Conference

2. Oil Price and Exchange Rates: A New Perspective • Motivation of this paper: a better understanding of the relationship between Oil Prices & Exchange Rates • The role of the dollar… • …in the new economic environment: Emerging countries, more especially China & India Moving correlation between the real effective exchange rate of the dollar and real oil prices (m/m variations over two years) Sources: DataStream, Saint Louis Fed Economic Data Research October 2011, 30th USAEE/IAEE North American Conference 2

3. Oil Price and Exchange Rates: A New Perspective • Oil Prices & Exchange rates: A brief Review of literature • Bilateral Causality (Percebois, 2009) • Effect on World demand through local prices (Krichene, 2005; Zhang & al., 2008) • Chinese Effect (Bénassy-Quéré & al., 2005) • Trade Balance & petrodollar recycling effect (Amano & Van Norden, 1998; Bénassy Quéré & al., 2005; Coudert & al., 2007) • Oil as a Financial Asset(Sadorsky, 2000; Zhang & al., 2008) • Monetary Policy Effect(Barsky & Killian, 2002) • Target Revenue Effect(Krichene, 2005) October 2011, 30th USAEE/IAEE North American Conference 3

4. Oil Price and Exchange Rates: A New Perspective October 2011, 30th USAEE/IAEE North American Conference 4

5. 30 25 20 15 10 5 0 Central and Latin America United States EU Japan China India Middle East 1990 2000 2009 Oil Price and Exchange Rates: A New Perspective • The necessity of a Synthetic Index:Previous Studies on the interaction between the exchange rate and the oil price relate either to a real effective exchange rate of the dollar or a euro-dollar exchange rate • Main reason: Oil is quoted in dollar... • ...While the USA oil demand represents an ever-decreasing proportion of world demand Oil demand from 1990 to 2009 in % of world demand Sources: BP Statistical Review of World Energy2010 October 2011, 30th USAEE/IAEE North American Conference 5

6. Oil Price and Exchange Rates: A New Perspective • The Synthetic Index: SER • where, in t, qj,t represents the real bilateral exchange rate (direct dollar quotation) of the currency of country j and wj,t the proportion that country j represents of total oil demand • Unlike the real effective exchange rate of the dollar, our synthetic exchange rate retains a weighting that does not correspond to the weight of each country in US trade, but to the weight of each country in total oil demand • The countries selected in formulating this synthetic exchange rate are either historically large consumers of oil or emerging countries whose consumption represents a relatively growing share of the world’s oil consumption: Brazil, China, the USA, India, Japan, the United Kingdom and the Euro zone countries October 2011, 30th USAEE/IAEE North American Conference 6

7. Oil Price and Exchange Rates: A New Perspective • In order to examine the relevance of this synthetic exchange rate, we will now test the existence of a long-term relationship between the real oil price and the real effective exchange rate of the dollar over the periods 1995-2010 and 2001-2008, then repeat the test for the real oil price and the synthetic exchange rate over the same periods • The data: • Monthly data extracted from Datastream and the IEA • Our sample covers November 1994 to January 2010 period • Logarithmic series and using series of the real effective exchange rate of the dollar (LREER), the synthetic exchange rate (LSER) and oil prices (LOILP) deflated by the USA consumer price index. • After having verified the order of integration of our three series using Augmented Dickey-Fuller (ADF) and Philips-Perron (PP) unit root tests, we can conclude that all our series are integrated of order one. October 2011, 30th USAEE/IAEE North American Conference 7

8. Oil Price and Exchange Rates: A New Perspective • November 1994 to January 2010: After carrying out cointegration tests between our LOILP/LREER series and the LOILP/LSER series from 1994 to 2010, there is no evidence of a cointegration at the 5% confidence level in both cases. October 2011, 30th USAEE/IAEE North American Conference 8

9. Oil Price and Exchange Rates: A New Perspective • May 2001 to August 2008: we can conclude that a relationship of long-term equilibrium exists between the real oil price and the synthetic exchange rate. October 2011, 30th USAEE/IAEE North American Conference 9

10. Oil Price and Exchange Rates: A New Perspective • The equation of the resulting long-term relationship is as follows: LOILP(t) = 45.48 - 8.72 LSER(t) + z(t) • Then we build a Vector Error Correction Model • In the oil price equation, the error correction term is negative and has an impact on the log variation of oil prices at the 5% level of significance. There is therefore a stabilizing force that returns oil prices to their long-term level. The error correction term in the synthetic exchange rate equation is also negative and has an impact on the log variation of our synthetic exchange rate at the 5% level. October 2011, 30th USAEE/IAEE North American Conference 10

11. Oil Price and Exchange Rates: A New Perspective • Causality Test: Exogeneity Test • The absence of causality of LSER towards LOILP can be rejected at the 5% level for the VAR models with 2 to 8 time lags. Therefore, although LSER has no impact on LOILP in the very short term as per Granger, one can see a short- and medium-term dependence of LOILPs on LSERs. October 2011, 30th USAEE/IAEE North American Conference 11

12. Oil Price and Exchange Rates: A New Perspective • With the high volatility of the exchange rate over the past 15 years and the explosion in the oil demand from the emerging countries since 2000, the long-term relationship between the dollar and the oil price observed empirically in the past seems to have changed • The cointegration tests we carried out reveal the existence of a long-term relationship between the oil price and the synthetic exchange rate over the period 2001 to 2008 - a period during which the oil demand in emerging countries saw its strongest growth • Next Step ? • Include Middle East Countries in our sample for a better understanding of the exchange rate / oil price relationship • Impact of currency reserve diversification October 2011, 30th USAEE/IAEE North American Conference 12

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