Why Brent fell below the $100/bbl mark on Wednesday
There is never a shortage of ridiculous reporting and analysis when it comes to oil. In the market, two leading global investment firms have given diverse opinions on oil. On the one hand, Citigroup has set a price of $65/bbl for WTI crude by the end of 2022 and a possible target of $45/bbl for WTI by the end of 2023. On the other hand, JP Morgan Chase has pegged oil prices at a possible high of $380/bbl, at which rate most of the oil consuming nations would either be bankrupt or close to bankruptcy. The truth lies in between.
Obviously, for a market that is largely exasperated with the consistently high crude oil prices, the Citi report looked more enticing and credible. After all, when the hawkish Fed policies are pushing the world towards a recession, oil price targets of $380/bbl are fantastic, to say the least. The Citibank report of $65/bbl target looked a lot more credible. This was one of the key factors that drove oil prices lower. After all, the one factor that has invariably destroyed oil prices even in the past has been the fear of an outright recession.
The sharp drop on Wednesday was the continuation of the fall over the last few days. The fall came over fears of muted demand due to a possible recession. Citibank has advised its clients that if the economic slump continued, then they should prepare themselves for $45/bbl oil by 2023. Oil prices lost more than 15% after this report was released. The fall in oil prices could actually have been a lot steeper had it not been for the supply shortages created by pushing Russia out of the oil market via imposition of sanctions over Ukraine.
Remember, oil had touched a peak of $140/bbl about 3 months back and is down nearly 30% from that level. The spike in oil may have been triggered by the Russia sanctions but the recent fall in oil prices is being purely driven by the fears of a recession. Normally, oil demand has been simplest and clearest indicator of a recession and with two quarters of negative real GDP growth, it looks increasingly likely that oil prices could also gradually deflate. That is the trend that we have seen in the last few days in the oil markets.
More and more economists are veering around to the view that global recession is now almost inevitable amidst aggressive central bank tightening. While the intent to stave inflation is positive, past experience is that it normally ends up as recession. Some central banks like the US Fed are deliberating trying to engineer a slowdown to contain inflation. Soft landing is what the Fed is trying, and the most obvious casualty of any soft landing attempt in the past has been the price of oil. We saw that in 1998, 2008 and in 2020.
How low could the price of oil go. Even Citigroup has cautioned that oil demand goes negative only in the worst global recessions. That is because when corporations go bankrupt, it suddenly dries up spending forcing inventories to be offloaded at bargain prices. That is again a worst case scenario. However, in its report, Citigroup has pointed out that in a proper recession, oil prices could plunge to $65/bbl by end of 2022. But the real cues to the future of oil prices may lie in supply and not so much on the demand side.
Despite the recent fall in oil prices, oil prices may stay elevated due to supply side cues. For instance, a strike by Norwegian oil and gas workers was pushing up prices and could have hit supplies to Europe which gets 25% of its energy from the Nordic nation. The government intervened to address the issues of oil workers over wages and for now the situation in Norway is under control. However, Libyan supplies are still disrupted. Even Saudi Arabia is not likely to increase its supplies meaningfully in the coming months.
Structural supply issues in the oil market still exist and will keep prices high even if demand slows. To that extent, the level of $100/bbl may be crucial and that may decide the future direction of oil.
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