Earlier this week, Brent crude fell below $100 per barrel for the first time in months. So did West Texas Intermediate. Copper dropped to the lowest in almost two years. It looked like inflation had done its evil deed. A recession was coming, and demand for commodities was about to plunge. And then both oil and copper rebounded. It lasted all of one day, although the price of copper has been fluctuating with the flow of news from China and the prospects of its economy for the rest of the year and the medium term. The latest copper price rebound was, in fact, attributed by some to the possibility that the Chinese government would provide additional stimulus to keep the economy going at a healthy pace.
The rebound in oil, however, was easy to see coming despite the notorious uncertainty of oil markets. And the reason it was easy to see coming was fundamentals. Whatever happens in the speculative market, the fact that the global supply of oil is tight while demand is very much alive and still rising cannot be ignored.
The Financial Times out it quite clearly. In an article from earlier this week addressing the price drop across commodities, the authors said that “Hedge funds have been central to the recent price declines across commodities — selling out of long, or positive, positions in certain commodities and often replacing them with bearish wagers.”
If the big scare of 2020 and 2021 was Covid, this year has two: Russia’s Vladimir Putin and recession. And it is increasingly looking like the latter is overtaking the former in terms of scare value.
Talk about recession is all over the news. Central banks are being targeted with criticism for tightening monetary policy too fast, accelerating recessionary pressure. It was only a matter of time before hedge funds decided to play it safe and start selling out. But, and this is the important bit, this has nothing to do with fundamentals. Fundamentals are why oil was up a day after the dip.
Just how much nothing market price movements have to do with actual demand and supply sometimes was recently highlighted by Wells Fargo. According to the bank’s investment strategy division, the United States, the world’s largest oil consumer, is already in a recession.
“There’s the technical part of the recession, but then there’s the meaningful deterioration in consumption and employment,” Wells Fargo Investment Institute’s senior global market strategist Sameer Samana told Bloomberg this week. “The technical part is a first half story and the brunt of the unemployment and consumption is the second-half,” Samana added.
Inflation, according to Wells Fargo analysts, has proven to be much faster and more broad than initially expected, consumer sentiment has as a result worsened, and businesses are changing their spending plans. But oil demand is still robust as it appears to be across the world, even though some analysts are projecting a decline. According to Citi’s Ed Morse, for example, “Almost everybody has reduced their expectations of demand for the year.” Demand was “simply not growing on an empirical basis to the degree that people had expected,” Morse told Bloomberg TV.
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Demand might not be growing per expectations—it would have been a wonder at these prices—but supply is not exactly booming, either, which was what probably motivated Saudi Arabia’s latest price hike for Asian buyers to near-record levels. Sellers don’t tend to hike their prices when they expect demand for their goods to decline.
No wonder, then, that Goldman Sachs, unlike Citi, says that oil could yet hit $140 per barrel, even with all the recession fears swirling around the market. “$140 is still our base case because, unlike equity, which are anticipatory assets, commodities need to solve for today’s mismatched supply and demand,” Goldman’s Damien Courvalin told CNBC this week.
These price projections, both from Citi and from Goldman, do not factor in supply disruptions—the same supply disruptions that just a couple of months ago, even a month ago, held markets captive. The disruptions are mainly expected to come from Russian oil exports, but this may have by now been factored into prices as there are still close to six months until the European Union’s oil embargo enters into effect.
Meanwhile, alternatives to this supply for Europe remain few and far between simply because of the size of Russian oil exports to the continent. This would likely continue having a bullish effect on oil prices, whatever the economic trends. Even if a recession dampens the demand for oil, it would take quite a while for real demand destruction of the kind that Citi says could push oil to $65 per barrel.
Recession fears have solid foundations. There is little doubt about it. Commodity fundamentals, however, not only in oil and gas but in agricultural commodities and metals, have not changed just because hedge funds have suddenly started worrying about a recession. They are still tight. And this is putting a floor under prices that will remain there as long as supply remains tight.
By Irina Slav for Oilprice.com
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And while a hard recession normally leads to a demand destruction and a decline in prices, this time it will neither adversely impact demand nor prices because of global energy shortages and a shrinking global oil spare production capacity including OPEC+’s. That is why I project that high oil prices are here to stay for at least the next five years or until global investments in production capacity expansion reaches fruition.
Tough anti-inflationary measures by Central banks normally end in a recession. But in the current situation, even a harsh recession in the major economies could neither lead to a meaningful demand destruction nor dampen prices. So we end up with a shrinking economy with both demand and prices still surging and continuing to feed into inflation.
Based on the above analysis, Brent crude could touch $120 a barrel before the end of the year. It could even rise beyond $130 if the G7 nations decide to go ahead with their futile notion of capping the price of Russian oil and Russia retaliates by cutting its oil exports.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London
Oil prices are a bit stickier. OPEC will simply cut supply to support price. Demand destruction has started, but the impact can be offset by supply destruction. Investors in the oil industry have already shown they require higher profits than in past business cycles. The competition of renewables adds risk to those investing in oil. Thus they require higher profit margins and lower investment will provide price support.
But oil near $100 a barrel pretty much guarantees the world will accelerate the shift to clean renewable energy, and more importantly, the public will shift to electric vehicles as fast as possible to save 75% on operation cost of the vehicle.
The beginning of the end is now upon us and will soon be in the rear view mirror. The Russian invasion of the Ukraine, put a temporary spike and support on oil prices, but that will quickly be managed away by other sources and demand destruction as we are already seeing happen. 12 to 18 months from now it will be behind us, even if the war continues. Soon we will reach the point where even those tied directly to oil can see the writing on the wall.