A rapid appreciation of the U.S. dollar may send Brent oil to as low as $20 a barrel, according to Morgan Stanley.

Oil is particularly leveraged to the dollar and may fall between 10 to 25 percent if the currency gains 5 percent, Morgan Stanley analysts including Adam Longson said in a research note dated Jan. 11. A global glut may have pushed oil prices under $60 a barrel, but the difference between $35 and $55 is primarily the U.S. dollar, according to the report.

“Given the continued U.S. dollar appreciation, $20-$25 oil price scenarios are possible simply due to currency,” the analysts wrote in the report. “The U.S. dollar and non-fundamental factors continue to drive oil prices.”

Brent crude capped its third annual decline in 2015 and has already lost more than 11 percent so far this year. The Organization of Petroleum Exporting Countries effectively abandoned output limits in December, potentially worsening a global glut, while U.S. stockpiles remain about 100 million barrels above the five-year average.

David Fuller's view

The US Dollar Index has remained rangebound since first breaking briefly above 100 in March 2015, so I do not think its earlier strength is the main driver for lower oil prices today.  Instead, oil producers are straining sinews to increase output in a desperate effort to slow the downward spirals in their economies by selling even more crude, albeit at lower prices. 

This destructive situation will persist until something suddenly lowers oil production, preferably a new Saudi-led agreement to reduce output among OPEC countries and other leading suppliers such as Russia.  However, this prospect has been delayed by understandable bitterness between the primarily oil exporting countries.  Moreover, the USA was the Saudi’s main target when they abandoned production limits.  However, it is still producing approximately nine million barrels of crude a day, thanks to the technological efficiency of shale oil producers. 

Meanwhile, the Middle East is an increasingly unstable tinderbox.  This time Daesh is not the main problem, as it is being reduced by the uneasy alliance including the US, Russia, Turkey and the EU. Instead, increasing Sunni/Shia conflicts in the Middle East, plus social tensions now that subsidies in the wealthier regions are being reduced, has the potential to disrupt oil production.

This is discussed in further detail in the Audio.