Oil Price Outlook Cloudy on Stronger Dollar

NEW YORK ( TheStreet) -- Oil prices were trending lower Monday as the outlook for the dollar strengthened on prolonged eurozone debt contagion fears.

January West Texas Intermediate (WTI) futures was falling $1.29 to $96.38, and the January Brent crude contract was down 96 cents to $106.60. The drop comes as the U.S. dollar rose against a basket of major currencies. The dollar index was up 0.5%. A stronger dollar tends to suppress gains in the dollar-denominated commodity.

"The shelf-life for European turmoil is not as short as many would like it to be," said Brian Habacivch, a senior vice president at energy management company Fellon-McCord.

The inability of the U.S. congressional super committee to reach an agreement on budget cuts and Chinese Vice Premier Wang Qishan's warning during trade talks in the southwestern Chinese city of Chengdu that "we are facing a very serious global economic crisis," also provoked the flight to safety in the U.S. dollar.

The dollar's preeminence as the world's reserve currency is growing amid Europe's debt turmoil, appreciating 7.2% even after Standard & Poor's cut the U.S.'s AAA credit rating on Aug. 5 -- the second-best performance after the yen among developed nations, according to the Bloomberg correlation-weighted currency indexes.

This, as foreign banks seeking safe, liquid investments double their deposits at the Federal Reserve to $715 billion from $350 billion since the end of last year, the report said. Bloomberg said that according to inter-dealer broker ICAP's survey of 80 financial institutions, 47 non-U.S. banks held balances of more than $1 billion at the New York Fed as of Sept. 30, up from 22 at the end of last year.

"WTI had a very brief moment at $100, but Fellon-McCord's view has consistently been that any move above $100 would be very short-lived in the teeth of dollar strength and global economic uncertainty," said Habacivch.

"Given the current inverse relationship between crude and the dollar, a strengthening dollar will provide headwinds to crude," said Matt Smith, commodity analyst at Schneider Electric's Summit Energy. "Diversification by Europe into foreign assets such as the U.S. makes sense given the problems they face at home -- is a risk mitigation exercise."

The growing number of U.S. dollar deposits "will support the dollar and thereby put pressure on oil," said PFGBest senior energy analyst Phil Flynn.

In addition to the typical strong dollar equals weak commodities argument, banks seeking safety would suggest a reduction in liquidity for risk assets, said TAC Energy trader Mark Anderle.

"As liquidity goes away, as we saw in 2008, selling across risk assets can be fierce, as traders are forced to liquidate levered positions simply because they need to raise cash to pay margins," Anderle pointed out.

"If we see another liquidity crisis like we did in '08, it's certainly possible to have another collapse in commodity prices."

Energy stocks were falling. CNOOC ( CEO) was tumbling 5.4% to $177.96; BP ( BP) was losing 2.2% to $41.53; Royal Dutch Shell ( RDS.A) was slumping 2.9% to $67.58; Marathon Oil ( MRO) was falling 1.9% to $25.63; TransCanada ( TRP) was down 0.6% to $40.23; Baker Hughes ( BHI) was tumbling 4.3% to $51.74; and Hess ( HES) was losing 3.4% to $57.71.

-- Written by Andrea Tse in New York.

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