One popular saying in the oil industry says that the only cure for high oil prices is high oil prices. With a war in Europe, tight global supply that's about to get even tighter, lockdowns in China, and economic uncertainty rife, oil prices may have finally become too high to be sustainable. While prices rebounded somewhat on Tuesday, Brent crude earlier this week slipped below $100 for the first time in weeks as worry about Chinese demand weighed on international benchmarks. And it could get worse if the spread of the coronavirus continues, CNBC reported, citing Andy Lipow from Lipow and Associates.
"The spread of Covid in China is the most bearish item affecting the market," Lipow told the network. "If [Covid] spreads throughout China resulting in a significant number of lockdowns, the impact on oil markets could be substantial."
Yet Covid is not the only bearish factor for oil prices. Reuters' John Kemp noted in his latest column that an economic slowdown in Europe and North America has also contributed to the latest trends in oil prices. Also, Kemp noted, there was heightened uncertainty and volatility in markets, which made large oil buyers such as hedge funds adopt a more cautious approach to buying.
The coordinated release of as much as 240 million barrels over several months by the United States and members of the International Energy Agency has also served to lower prices but the effects of this move, based on historical evidence, are likely to be short-lived, especially since their daily total will be lower than what the IEA expects to be lost in Russian supply this quarter.
Related: Germany Has Enough Gas Through Summer Without Russian Supply
Despite the decline in prices, concern about a possible global recession remains, not least because even if crude oil prices wane, fuel prices have not. As the Wall Street Journal reported earlier this month, the combination of high oil prices, labor shortages, and strong demand for goods have combined to cause a lot of pain for the freight transport industry. This pain will likely be passed on to customers, eroding their purchasing power.
Yet, according to experts, it is too early to talk about the danger of a recession, and oil prices will need to stay at higher levels for a prolonged period of time to make this danger immediate, according to a Yahoo Finance report.
According to Andy Lipow, again, Brent crude would need to remain at around $120 per barrel for the recession risk to become serious enough to worry about it in the U.S. According to Stewart Glickman from CFRA Research, the benchmark needs to stay above $125 per barrel in order to trigger a recession in the United States.
In Europe, however, a recession is a lot more likely because of higher natural gas prices, according to a senior portfolio manager from ICAP ETF. Currently, natural gas prices in Europe are equivalent to $240 per barrel of oil, which has undermined the competitiveness of European industries and caused much bill pain for consumers, Jay Hatfield told Yahoo Finance.
Despite all these latest developments, there are still tailwinds for prices, as proven by the rebound of Brent to $100 and above, as of the time of writing of this article. OPEC this week made it clear to the EU that it will not step in to fill a potential gap left by lost Russian barrels in case Brussels decides to impose an embargo on Russian hydrocarbons. And it painted a grim picture.
"We could potentially see the loss of more than 7 million barrels per day (bpd) of Russian oil and other liquids exports, resulting from current and future sanctions or other voluntary actions," OPEC Secretary General Mohammad Barkindo said, as quoted by Reuters. "Considering the current demand outlook, it would be nearly impossible to replace a loss in volumes of this magnitude."
Such a loss is highly unlikely as the EU would be unwilling to self-inflict such damage, yet the very prospect of supply loss of such magnitude is likely to keep countering tailwinds such as the demand destruction fears prompted by China's lockdowns.
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By Irina Slav for Oilprice.com
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The Ukraine conflict has added a premium estimated at $20-$30 to the price of oil. However, this premium has virtually evaporated and with eventual peace in Ukraine, Brent crude could retreat to $94-$95 a barrel possibly hitting $100 by the second half of this year as a result of an increasingly tighter market.
A Brent crude price of $100 isn’t only sustainable but it is here to stay for the foreseeable future underpinned by a tightening market, a shrinking global spare oil production capacity including OPEC+ and depleting global oil inventories. Moreover, it takes at least five years for investments in the expansion of oil production capacity to reach fruition.
The global economy can tolerate a Brent crude ranging from $100-$110. Moreover, such a range stimulates the three chunks that make up the economy, namely, global investments, the global oil and gas industry and the economies of the oil-producing nations.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London