As worries about an economic recession mount, coupled with unfavorable factors such as a strong U.S. dollar, international oil prices have fallen from highs, with Brent crude oil and U.S. crude oil both “breaking 100”.
On July 6, Eastern Time, Brent crude oil futures fell below the $100 mark for the first time since April 25. The day before, U.S. crude oil futures had taken the lead in falling below $100. On the 6th, both major crude oil futures indicators closed at their lowest levels since April 11, and were in the technical oversold zone for the second consecutive day.
Compared with the closing price high on March 8 this year, New York crude oil futures fell 20.35% and Brent crude oil futures fell 21.32%, both falling into bear markets.
Zhu Runmin, a senior economist in the oil industry, said in an interview with a reporter from the 21st Century Business Herald that concerns about economic recession are still at the expected stage and have not yet truly become a reality. However, as time goes by, the probability that this recession will eventually become a reality is far greater than the probability of no recession. With the advent of economic recession, the world will face a decline in oil demand, and international oil prices may still have a lot of room for adjustment before entering a new complete cycle, which will take a long time. But on the other hand, even though international oil prices have plummeted, they are still at a relatively high level.
Wang Chengqiang, director of the New Era Futures Research Institute, told a reporter from the 21st Century Business Herald that for the crude oil market, the marginal supply curve has stabilized and the demand curve has shifted significantly to the left, which means price collapse. Global commodities have completed the bubble development process due to “supply shocks”. At a time when the economy is in decline, the “demand contraction” drive temporarily overwhelms the “supply shocks” and has become the main contradiction in the current market.
After the oil price “broke 100”, there is still uncertainty in the future. Brent crude oil and WTI crude oil began to rebound slightly on July 7. For the future, the strength of these two forces, supply shock and demand reduction, will determine the next trend of oil prices.
Multiple negative factors drag down international oil prices to “break 100”
Although the supply side has not yet stabilized, traders have shifted more attention to the demand side, worried that the economic recession will reduce crude oil demand.
Faced with high inflation not seen in decades, the Federal Reserve and other central banks began to aggressively raise interest rates. Wang Chengqiang said that the Federal Reserve has raised interest rates by 25 basis points, 50 basis points and 75 basis points in March, May and June respectively, and there is still a 93.3% probability of raising interest rates by 75 basis points on July 28. Fighting inflation has become the Federal Reserve’s top goal.
At the same time, the U.S. economy is also showing signs of weakness. On June 29, the final revised data released by the U.S. Department of Commerce showed that U.S. real GDP fell by 1.6% on an annual basis in the first quarter of 2022, a decrease of 0.1 percentage points from the previously released revised data. It was the first time it turned negative since the epidemic crisis. Wang Chengqiang believes that due to recent weak U.S. economic data, financial markets are actively trading “economic recession.” At the same time, U.S. long- and short-term Treasury yields have inverted multiple times, indicating that there may be a risk of economic recession in the next year.
Fawad Razaqzada, a senior analyst at Jiasheng Group, told a reporter from the 21st Century Business Herald that central banks of various countries are currently focused on reducing inflation and tightening money aggressively, hoping to control inflation to a certain extent, even at the cost of recession. A growing number of analysts predict that many major economies will slip into negative growth in the coming months. Worries about weakening demand are starting to outweigh worries about tight supply.
Razaqzada analysis said that judging from recent macro data, the U.S. economy may fall into a downturn later than the euro zone. Some economists believe that the U.S. economic recession may not be severe, but no one guarantees that it will not be a long-term recession. In fact, persistently high inflation could constrain the Fed from easing money quickly in a recession. That is, recessions that occur during periods of high inflation may last longer than recessions that occur under other circumstances.
In addition to the gloom of the economic recession, high oil prices themselves have also had a certain impact on demand. U.S. gasoline consumption has been sluggish during the peak season. Data released by the U.S. Energy Information Administration (EIA) show that in addition to the collapse in demand due to the epidemic in 2020, gasoline consumption last week reached the lowest point since the same period in 2014. Fuel inventories have risen by more than 4 million barrels in the past two weeks, while inventories typically draw down at this time of year.
In addition, the strengthening of the U.S. dollar is another important factor that has dragged down oil prices in recent trading days. The U.S. dollar index broke through the 107 mark on the 6th, hitting a new high since 2002, while the euro fell to a 20-year low.
Zhu Runmin analyzed that the combination of a strong U.S. dollar and high oil prices will inevitably have a strong inhibitory effect on demand. This has been clearly shown in the weekly data from the U.S. Energy Information Administration, which shows that oil consumption is not strong during the peak driving season in the United States. However, while the supply problem remains unresolved, the international crude oil price’s “over 100” is only reflected from the demand side and is not a balanced and sustainable price.
Compared with industrial metals, which are more sensitive to economic cycles, crude oil has performed relatively well. Wang Chengqiang told reporters that the U.S. dollar index soared to a 20-year high, and the Federal Reserve continued to increase interest rates and tightened financial conditions, which directly triggered the collapse of nonferrous metals, which recorded the largest single-quarter decline since the subprime mortgage crisis. Among them, copper, known as the “economic barometer”, has fallen back to the low level one year and seven months ago.�From historical highs, the maximum decline exceeded 30%. Although there is no substantial reversal in the supply and demand fundamentals of basic industrial metals, macroeconomics and capital hedging needs have roiled the situation and affected future expectations.
In Wang Chengqiang’s view, the decline in crude oil was significantly lower than that in industrial metals. The former only erased several months of gains, while the latter erased more than a year’s gains. The geopolitical crisis has not yet been resolved, and the speculative risk premium in crude oil still exists. The sharp drop in crude oil may be a delayed response to the contraction in demand. The international crude oil market has switched its focus from “supply shock” to “demand contraction”, triggering high prices to compensate for the decline.
Wall Street Divides
Amid the correction in oil prices, Wall Street has already seen huge differences in its outlook for the market, with huge uncertainties existing on both the supply and demand sides.
From the supply side, Russian supply poses the greatest uncertainty. JP Morgan analyst Natasha Kaneva predicts that if the G7 implements the Russian oil cap, Russia’s retaliatory supply cuts may cause Brent crude oil to surge to $380 in extreme circumstances.
Goldman Sachs commented that as the global supply gap has not yet been resolved, oil prices have been “overshooting” and it is too early for oil prices to plummet due to concerns about economic recession. Jeffrey Currie, global head of commodities research at Goldman Sachs, maintained a target price of $140 for Brent oil, saying the spot market is the tightest in history and available inventories are extremely low.
On the other hand, from the demand side, Citigroup’s global head of commodity research Ed Morse gave a completely opposite prediction: If there is a global economic recession that seriously affects oil demand, crude oil prices may fall to 65 per barrel by the end of this year. U.S. dollar; crude oil prices could fall to $45 a barrel by the end of 2023.
Louise Dickson, an analyst at Rystad Energy, an energy research institution, said that while demand has weakened, oil companies have gradually responded to oil prices of US$100 per barrel by increasing production, so they may see more crude oil entering the market later this year, This further drives down prices.
Overall, oil demand will be suppressed as the economy slows or even declines, but insufficient inventories and tight refinery capacity at this stage will provide support for oil prices in the second half of this year. Deutsche Bank expects Brent crude oil to remain near $110 per barrel by the fourth quarter of this year. A sharp economic slowdown will push oil prices back to $90/barrel by 2023.
PVM Oil Associates analyst Stephen Brennock commented that concerns about an economic recession have caused fear, but in fact, oil fundamentals remain solid.
Some investment banks focus on “supply shocks” and give extremely high price outlooks, while others give extremely low price outlooks based on “demand contraction.” The polarization of this outlook reflects the complexity and changeability of the current market environment. Price drivers will swing between supply and demand, which determines that high volatility in the oil market will be the norm. Wang Chengqiang predicted that in the long term, under the influence of issues such as the politicization of the energy economy and the de-globalization of international trade, the crude oil market may experience short-term and long-term trends.
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