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12.04.19
Insights

The Norwegian krone’s correlation to the Brent oil price

Dag A.D. MESSELT

«When the oil price tanks eyes turns to the NOKie». We often see the Brent oil price as a factor for explanation of the moves in the Norwegian krone (NOK) versus other currencies, but how does it really work over time? We have been looking closer to this relationship and have some interesting findings. These findings can be split in three levels:

  • Changes in the oil price and impact on the correlation, Brent oil prices up and down
  • The level of correlation for different Brent oil price levels; luxury high and crisis low
  • The correct data to look at? Brent in dollars (USD) or in NOK? NOK to euro (EUR) or trade weighted NOK?

Correlation between NOKEUR and Brent oil price in USD

FIGURE 1 – Correlation between NOKEUR and Brent oil price in USD

Insight 2019 04 - NOK and correlation to Brent oil price - Image 1

Source: Alfred Berg, Bloomberg, April 2019

In figure 1 we can see the correlation and the Brent oil price in USD. The 12 month correlation is to say it mildly very volatile and it is difficult to defend that there is a stable correlation between the NOKEUR and the Brent oil price in USD.

FIGURE 2 – Correlation between NOKEUR and Brent oil price in USD – When the oil price tanks

Insight 2019 04 - NOK and correlation to Brent oil price - Image 2

Source: Alfred Berg, Bloomberg, April 2019

As can be seen in figure 2, the correlation is rocketing when there is a big drop in the oil price. But how is it when the Brent Oil price goes up a lot?

 

FIGURE 3 – Correlation between NOKEUR and Brent oil price in USD – When the oil price rockets

Insight 2019 04 - NOK and correlation to Brent oil price - Image 3

Source: Alfred Berg, Bloomberg, April 2019

As can be seen in the figure 3 the correlation drops and at times significantly when the Brent oil price increases strongly.

There is a mismatch here, is the Brent oil price only a valid indicator  for the direction of the NOK when it falls, i.e. leads to more, in theory, difficult times for Norway?

What about the stable periods, how correlated is it then?

 

FIGURE 4 – Correlation between NOKEUR and Brent oil price in USD – When the Brent oil price is «stable»

Insight 2019 04 - NOK and correlation to Brent oil price - Image 4

Source: Alfred Berg, Bloomberg, April 2019

As seen in figure 4, the correlation was falling albeit with high volatility in the golden oil days where we had the Brent oil price over 100 USD for a period of around 3 years. In this period the correlation was in average around 0.3. This differs a lot to the more recent period with oil prices below 60 USD, where the correlation was steady around 0.8.

 

First Conclusion – NOKEUR and Brent oil price correlation

For me it is quite obvious from the above that the big currency money is not that close to the NOK and that they tend to come around when the Brent oil price is plummeting or staying at low «crisis» levels. Are the currency traders forgetting the NOK in the good times with steady high or increasing Brent oil prices?

 

Fine tuning – The right data for correlation between the NOK and Brent oil price

Here above we have used the quick and dirty explanation we often meet when discussing with international investors.

Can we adjust the data to get more relevant correlation numbers? Yes.

Firstly, the Oil price relevant for the Norwegian state finances and job market is the Brent oil price in NOK. At least it is more relevant than the Brent oil price in USD.

Secondly, using the NOKEUR gives a lot of noise stemming from the EUR’s specific situation. E.g. the in the period between the financial crisis after Lehman Brother’s bankruptcy  until the Outright Monetary Transactions (OMT) launch by the ECB in the fall of 2012, the NOK strengthened a lot to the EUR, but mainly due to the perceived weak fundamentals of the EUR. Once the OMT launched, the trend was reversed and the NOK weakened to the EUR until the oil price crisis started in 2014. With other words nothing to do with the oil price and noise in the above study.

First correction – Using Brent oil price in NOK

FIGURE 5 – Correlation between NOKEUR and Brent oil price in USD and in NOK

Insight 2019 04 - NOK and correlation to Brent oil price - Image 5

Source: Alfred Berg, Bloomberg, April 2019

Compared to figure 1, we notice that the correlation when using the Brent oil price in NOK and looking at simple linear trend lines is roughly 0.2 under the correlation when using Brent oil price in USD.

What does this mean? Everything else equal, you would expect to see a more relevant Brent oil price in NOK to have a higher correlation to the NOKEUR. This is not the case, are international investors’ knowledge of this market to shallow?

 

Second correction – Using Trade Weighted NOK to dilute single currency specific impacts

 

FIGURE 6 – Correlation between Trade Weighted (TW) NOK and Brent oil price in NOK

Insight 2019 04 - NOK and correlation to Brent oil price - Image 6

Source: Alfred Berg, Bloomberg, April 2019

As figure 6 shows, the correlation falls a little further when looking simple linear trend lines for the correlation between Trade Weighted NOK and Brent oil price in NOK. It is noticeably how the correlation differs in the above described period from the financial crisis up until the start of the oil price crisis in 2014. Thereafter the difference in correlation is much less visible. This is logic as discussed above as the TW NOK correlation dilutes the specifics of the EUR.

How should we understand this? Except the above mentioned, there was no substantial difference and this can be explained by the fact that Norway trades a lot with Europe, hence the EUR has an important weight in the Trade Weighted NOK.

 

Conclusion on the historic correlation between NOK and the Brent oil price

There is a correlation, but it is very volatile, hence referring to a single number does not make sense. There seems to be a pattern where correlation increases when the market can smell trouble for the Norwegian oil related industry and the Norwegian state.

Adjusting to data series that are more relevant for the Norwegian economy at large and that way get closer to a fundamental description of the link shows that the correlation decreases.

Do international investors fully understand the mechanisms at work when they play a weakening NOK due to a fall or expectations of a fall in the oil price? It does seem that this is not the case as there is no mirroring when the oil price is strong.

I have worked for 25 years in international markets and I have seen this many times, investors cannot focus successfully on all things at all times, and therefore many of them play the NOK only when it looks bad and they tend to use the Brent oil price as an indicator of where the NOK is going.

Does this create an opportunity with the current historically weak NOK? Due to the fundamentals and the outlook of Norway compared to the rest of Europe, I think so.

 

I’m looking forward to reading your comments that can help us dig further to better understand.

Other articles on Nordic currencies:

Potential global trade war – Nordic exports and currencies

Weakening of Nordic currencies due to differing growth prospects?

Why is the Norwegian Krone so weak despite the stronger oil price?

The Norwegian Central Bank has little control of the Norwegian Interbank rates

The weakness of the Norwegian krone – Real NOK exchange rate

 

Dag A.D.Messelt

Head of International business Development

BNP Paribas AM – Alfred Berg

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