The Relationship between Oil, Exchange Rates, and Commodity Prices
Harri, Ardian, Nalley, Lanier, Hudson, Darren, Journal of Agricultural and Applied Economics
Exchange rates have long been thought to have an important impact on the export and import of goods and services, and, thus, exchange rates are expected to influence the price of those products that are traded. At the same time, energy impacts commodity production in some very important ways. The use of chemical and petroleum derived inputs has increased in agriculture over time; the prices of these critical inputs, then, would be expected to alter supply, and, therefore, the prices of commodities using these inputs. Also, agricultural commodities have been increasingly used to produce energy, thereby leading to an expectation of a linkage between energy and commodity markets. In this paper, we examine the price relationship through time of the primary agricultural commodities, exchange rates, and oil prices. Using overlapping time periods, we examine the cointegration relationship between prices to determine changes in the strength of the linkage between markets through time. In general, we find that commodity prices are linked to oil for corn, cotton, and soybeans, but not for wheat, and that exchange rates do play a role in the linkage of prices over time.
Key Words: cointegration, commodity prices, crude oil, exchange rates
JEL Classifications: C32, L71, Q11, Q40
Existing literature on crude oil's effect on commodity prices is thin, but several seminal articles highlight the underlying relationship between the two. Campiche et al. (2007) examined the covariability between crude oil prices and corn, sorghum, sugar, soybeans, soybean oil, and palm oil prices from 2003 to 2007 using a vector error conection model. Their cointegration results indicate that corn and soybean prices were cointegrated with crude oil price during the 2006-2007 time frame but not during the 2003-2005 period. Further results from the same study indicate that crude oil prices do not adjust to changes in the corn and soybean market. The authors concluded from their analysis that soybean prices seemed to be more correlated (through the biodiesel market) to crude oil prices than corn prices. A similar study conducted by Yu et al. (2006) analyzed the cointegration and causality of higher crude oil prices on the price and demand for vegetable oils. They conclude that the influence of shocks in crude oil prices on the variation in vegetable oil prices is relatively small, which appears to reflect results in Zhang and Reed (2008).
Another link between petroleum and commodity prices put forth by Abbot et al. (2008) is the relationship between rising crude oil prices and an increase in U.S. current account deficit. A byproduct of an increasing current account is a depreciating currency which makes exports more attractive and imports less attractive (exchange rate effects). Since early 2004, crude oil prices have steadily increased and the U.S. dollar has simultaneously decreased in value relative to most other high and low-income countries' currencies. Both of these factors have resulted in higher corn prices in the U.S., as the decreased dollar has resulted in cheaper corn exports in places like China and India. Because of this, corn exports have not decreased even as corn prices continue to rise.
Like Abbott et al. (2008), other studies (Hanson et al., 1993; Schnept, 2008; Trostle, 2008) all highlight the effects of changing crude prices on exchange rates, which "trickle down" to commodity prices. Nevertheless, a comprehensive evaluation of the relationship between exchange rates, oil, and commodity prices has not been conducted. Changes in these relationships have implications for risk management strategies and may affect longer term policy prescriptions for agriculture.
Following the literature, one can conceptualize the linkages between oil, exchange rates, and commodity prices as in Figure 1 . Here, we expect the "trickle down" effect of oil on commodity prices through exchange rates. …