Here's why LNG looks set to rival iron ore as a key influence on the Australian dollar

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Liquefied natural gas (LNG) exports may have become a hot political issue for the government in recent months, with Prime Minister Malcolm Turnbull intervening to guarantee domestic supply amid concerns of shortfalls, but LNG exports will not only boost Australian economic growth in the coming years, they’re also likely to become an influential driver of movements in the Australian dollar.

That’s the view of Joseph Capurso, senior currency strategist at the Commonwealth Bank, who says that LNG looks set to rival iron ore as a key driver of Australia’s terms of trade, and as a consequence the Australian dollar, in the years ahead.

“LNG is increasingly becoming an important commodity for Australia,” he says.

“We estimate oil and gas production — as measured by value added — will approach iron ore production in the next few years. The upshot is the LNG price is a growing influence on Australia’s terms of trade and AUD.”

Source: Commonwealth Bank

Capurso suggests that LNG’s influence on the Australian dollar has already been seen this year, helping to explain why the Australian dollar has risen back towards 80 US cents despite a sharp decline in the iron ore price.

“The ongoing recovery in the LNG price is an emerging part of the story supporting AUD,” he says. “The LNG price has increased by 45% since the cyclical low point in May 2016, and 13% so far this year.”

Along with renewed US dollar weakness, a smaller current account deficit and firmer base metals prices, Capurso says this helps to explain why the Aussie has rallied even with a sharp decline in the iron ore price seen since February.

This chart from the Commonwealth Bank shows the relationship between the price of Australian LNG sold to Japan overlaid against movements in the AUD/USD.

Source: Commonwealth Bank

As LNG prices have recovered, so too has the Aussie dollar.

And while LNG prices are unlikely to be as volatile as those in iron ore given most will be supplied under long-term contracts, Capurso says its influence on the Aussie will only increase further as production levels increase.

“The iron ore price will remain an important influence on the AUD,” he says.

“However, it is important to also be aware of changing trends in LNG and oil prices, given the growing importance of LNG in Australia’s export mix.”

LNG contract prices are linked to changes in Brent crude, meaning that moments in the latter will likely be used as a proxy for those in the former.

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