A STRONGER U.S. dollar is compounding an oil market rout that has seen crude prices fall by almost 20 percent this month and options trades suggest the market is preparing for deeper losses ahead.

    The accelerated oil price drop since the beginning of the year has been largely blamed on China’s stock market turmoil and its slowing economy, yet the dollar’s strength is emerging as another important bearish factor, traders and analysts said.

    The U.S. dollar index has risen more than 20 percent since mid-2014 as a relatively robust U.S. economy attracted investor flows from other regions. The Federal Reserve’s first increase in U.S. interest rates in a decade in December and the prospect for further rises are expected to continue underpinning the greenback going forward.

    Since oil is traded in dollars, a stronger greenback makes it more expensive for countries using other currencies to buy fuel, potentially denting demand.

    “No doubt, U.S. dollar is a key factor that is driving the oil price down,” said Oystein Berentsen, managing director of crude oil at trading company Strong Petroleum in Singapore, although he said there were many reasons for the price collapse, “the basic one being overproduction.”

    Crude oil futures have fallen more than 70 percent since mid-2014 as soaring global production leaves hundreds of thousands of barrels every day without buyers, creating an overhang that storage facilities around the world are struggling to cope with.

    Compounding this, analysts say that the robust dollar has been playing an increasing role in crude price falls since last November.

    “There is a foreign exchange problem, and it may get worse,” Morgan Stanley said in a note to clients this week.

    “When we assess the over 30 percent decline in oil since early November, much of it is attributable to the appreciation in the trade-weighted U.S. dollars,” Morgan Stanley said.

    Market data suggest that the dollar and U.S. crude are indeed closely linked.

    Since the start of 2015, the rolling one-year correlation between U.S. crude and the dollar weighted against a basket of currencies has had an average negative correlation of around 94 percent as the greenback strengthened and oil fell.

    Morgan Stanley said this trend could intensify if Chinese policymakers continue to steer the yuan lower in a bid to spur economic activity.

    “If rapid devaluation occurs, a 15 percent CNY [Chinese yuan] depreciation alone could send oil into the US$20s.” (SD-Agencies)