Why has Brent fallen so sharply to the $103/bbl levels

On Tuesday, the price of crude oil saw one of the sharpest falls. Brent Crude held just about $100/bbl but the West Texas Intermediate (WTI) crude actually dipped below the $100 mark. The single day fall on 05th July, the day after the American Independence Day celebration, was one of the sharpest fall in the last 3 months, as depicted in the graphic below. Effectively after peaking at around $139/bbl about two months back, the price of Brent Crude is not back to close to $100/bbl. 

On Tuesday, the West Texas Intermediate (WTI) crude futures settled below $100. The oil prices fell by over 8% in a single day as risk off sentiments pervaded all commodities. In fact, while crude may have been representative, even asset classes like gold which are safe havens, had a sharp fall in Tuesday. Of course, most of the industrial commodities like copper, aluminium and zinc did take a hit on concerns that with the world slowing and China locking down large swathes of its economy, demand could get badly constrained.

Oil cracked sharply on Tuesday on escalating concerns that a global economic slowdown would ultimately hobble demand for most of the commodities. Even in the past, crude oil prices have been prone to violent swings as traders fled to the exits after Russia invaded Ukraine. This is the first time in the last 3 months that we got to see such a violent fall in crude oil prices. In fact, the sentiments were only soured further by a research from Citibank, which pegged the likely value of crude at $65/bbl by end of the year 2022.

There is an anomalous situation visible in the oil industry. Oil futures are under pressure as rising interest costs are making it more expensive to hold on to oil inventories. At the same time, spot oil prices on physical barrels are still fetching enormous premiums. For example, Saudi Arabia very recently hiked its official selling prices to Asia with its flagship Arab Light crude price commanding a premium of $9.30 above its regional benchmark. There is still a lot of demand for oil as a commodity, but that is not translating into robust futures prices.

Oil, like any other commodity, is normally a battle between demand and supply. Crude oil prices have slumped sharply as weakening demand concerns are starting to outweigh fears of tight supply in the oil market. The fear in the market now is that most of the world’s leading economies, including the US and large swathes of Europe, will suffer negative growth in next few months. While this is likely to drag the US and EU into a brief recession, the real impact will be on oil demand and that is what the oil prices are reflecting.

As if the existing chaos was not enough, Shanghai launched mass testing for Covid in 9 districts after detecting several virulent cases the past two days. This once again calls into serious question, the demand recovery in one of the world’s biggest oil-consuming countries and also one of the biggest consumers of most of the commodities. The additional testing by the Chinese authorities raises serious concerns that more lockdowns could be implemented by the government as leading cities in China grind to a standstill.

However, even the most pessimistic trades don’t expect oil prices to really crash. For example, Russian oil is going to take a long time coming to the global markets, so the oil market will remain grossly undersupplied. Recently, a strike in Norway and supply disruption in Libya have also exacerbated supply lines and both being critical oil suppliers will keep the supply tight. That is the reason, most analysts concur, that despite signals of weakness, it was very unlikely that even in a worst case scenario, oil may not dip below $80/bbl.