Oil holding below $100 as debt debate continues

July 25, 2011 - 12:59 PM

NEW YORK (AP) — If the U.S. defaults on its debt, it would send shockwaves through oil markets that could push fuel prices even higher, analysts said Monday.

Experts disagree about how much oil prices will respond if lawmakers fail to raise the nation's debt ceiling by an Aug. 2 deadline. What's clear is that a default would sink the value of the dollar. When that happens, oil almost always goes up.

"If there's a default, everyone is going to be dumping dollars," said Rice University professor Ken Medlock, who has studied the historic relationship between oil and the dollar. "You should see massive inflation" for any commodity priced in dollars. That includes oil.

Oil was down slightly Monday with eight days left before the deadline. Analysts say they're still confident that Congress will not allow the nation to default, but oil investors could still hedge their bets and begin pricing in the possibility of a default by the end of the week.

Benchmark West Texas Intermediate crude for September delivery on Monday dropped 74 cents to $99.13 per barrel in afternoon trading on the New York Mercantile Exchange. In London, Brent crude fell 61 cents to $118.06 per barrel on the ICE Futures exchange.

Oil and the dollar have been entwined in an especially close relationship since 2000, Medlock said. When the dollar falls, he said, oil almost always rises.

Oil is priced in dollars and is heavily influenced by the dollar's value relative to other currencies. A sustained drop in the dollar sparks increased oil demand as investors holding foreign money can buy crude more cheaply. Increased demand pushes oil higher.

A weaker dollar also has an immediate effect on oil as people pull out of investments in the greenback and funnel money into commodities and stocks.

In addition a decline in the dollar means oil producers like Saudi Arabia earn less for every barrel they sell. Oil prices tend to rise when this happens because traders expect OPEC and other countries to cut production in response.

Independent oil analyst Andrew Lipow thinks a U.S. default could mean a plunge in oil markets — at least initially. The U.S. is the world's largest petroleum consumer, and if it can't pay its bills, demand for petroleum will surely fall, he said.

The rise in oil will come later as the dollar's influence eventually weighs on oil markets, PFGBest analyst Phil Flynn said. Prices will rise, heaping extra pressure on the economy by making gasoline, jet fuel, diesel and other fuels more expensive. After slipping to about $90 per barrel, post-default oil prices could eventually rebound to between $120 and $130 per barrel, Flynn said.

"You'll see a rush to commodities as well as emerging markets" like China and India, he said. "And guess what the emerging markets do when they get money — they buy oil."

Retail gasoline prices fell less than a penny on Monday to a national average of $3.694 per gallon, according to AAA, Wright Express and Oil Price Information Service. A gallon of regular is up almost 11 cents in the last month nearly 96 cents since the same time last year.

In other Nymex trading for August contracts, heating oil lost 2 cents at $3.1252 per gallon and gasoline futures gave up a penny at $3.0800 per gallon. Natural gas lost 2 cents at $4.345 per 1,000 cubic feet.

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Chris Kahn can be reached at www.twitter.com/ChrisKahnAP .