With Brent crude climbing steadily towards $130 per barrel, fears of an economic slowdown and even a slip into recession have reared their heads among traders, very likely reinforced by warnings of food supply troubles because of the war in Ukraine. It seems like everything is going wrong at the same time.
Oil prices soared as soon as Russia invaded Ukraine in what it euphemistically called a “special military operation” aimed at “demilitarizing” its eastern neighbor. As the conflict escalated and the West began implementing sanctions on Moscow, fears grew over potential action against Russia’s oil industry, which supplies around 7 percent of the world’s crude and is the biggest exporter of crude oil and oil products taken together.
Talks about oil sanctions marked the start of the week, and the market response was a sharper rise in oil prices. So far, nothing surprising. According to data about hedge fund buying activity in oil contracts, however, there are fears of a global economic slowdown, and while also unsurprising, this is most unwelcome.
In his weekly column on hedge funds and oil buying, Reuters’ John Kemp said the industry remained very bullish on oil, with the ratio to bearish positions at 7:1. This ratio signals that hedge funds are following recent geopolitical events in Europe closely, but they will be watching for demand destruction as oil prices remain elevated.
As oil prices rise, eventually, they tend to reach a certain point when demand destruction begins either through fuel conservation, as Reuters’ Kemp noted in his column, or simply because expensive fuels make everything else more expensive and discourage spending.
Yet such a trend would come at a very bad time for world economies. While news about Covid-19 all but dried up overnight with the Ukraine invasion, economies are still struggling with the pandemic. The United States, the world’s largest oil consumer as well as producer, booked an inflation rate of 7.5 percent for January—the highest in almost 40 years—and analysts now expect this to have risen closer to 8 percent in February.
Meanwhile, oil is not the only commodity on the rise. Wheat prices hit a record high amid the Russian-Ukraine conflict as the two are major exporters. Russia, the world’s largest exporter of the staple, has been heavily sanctioned in ways that make it a challenge to lift wheat cargos from the country. The 50-percent jump in wheat prices since the start of the invasion is making wheat more unaffordable. Add food insecurity to soaring oil prices, and a recession looks increasingly likely for many economies.
Perhaps even worse is the fact that, according to some analysts, this is not the end of the rally for oil. Giovanni Staunovo from UBS, for instance, forecast oil could stabilize around $125 per barrel unless the war drags on, in which case disruptions to global supply would persist, pushing oil to $150 per barrel.
According to Russia’s Deputy Prime Minister Alexander Novak, if the West sanctions Russian oil exports, the price for the commodity could reach $300 per barrel, and although this is quite an unlikely scenario, in reality, oil prices do seem to have quite a while left to rise.
The way things are going now, $200 per barrel is a clear possibility, according to Jeffrey Gundlach from investment firm DoubleLine. Speaking to TIFIN, Gundlach said that oil is on its way to $200, and the Fed may be pressed to raise rates while the country is going into a recession, which, he noted, had never been done before. Gundlach also said it was time to admit the U.S. was going into stagflation, and the latest increase in gas prices was only the beginning of the pain.
By Irina Slav for Oilprice.com
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