Whither oil prices?: Recent correction shows underlying concerns on demand

After a long streak of weekly gains, global oil futures ended last week with a deep slump. According to market analysts, this sudden reversal in trend highlighted underlying concerns among investors regarding the future outlook of demand and the higher risk of recession.

Oil markets snap 4-week winning streak as investors assess recession fears

Between early May and June, crude oil prices posted 4 straight weeks of gains and breezed past levels above $120/bbl two weeks ago on the heels of China demand optimism following lockdowns and record-high gasoline prices in the US.

By mid-June, however, the markets turned down with West Texas Intermediate crude for July delivery closing last week with a drop of $8.03, or 6.8%, and settling $109.56/bbl on the New York Mercantile Exchange. The global benchmark Brent crude for August delivery also declined by $6.69, or 5.6%, to settle at $113.12/bbl at the end of last week. This was the lowest finish since May 12 for WTI and the lowest close for Brent since May 20.

Slowdown in economic growth translates into demand concerns

Several analysts explained that the steep correction in global oil prices was largely driven by numerous challenges that the global economic growth dynamic has been facing. As the world’s central banks continue to adopt tight monetary policies to fight inflation, concerns that global economies could tip into recession are becoming more and more prevalent, analysts said.

The US Federal Reserve (Fed) increased the federal funds target rate by 75 bps to 1.5%-1.75% during its June 2022 meeting. This marked the sharpest rate hike in nearly three decades. Following Fed’s lead, central banks across Europe also raised interest rates to tame soaring inflation in the region.

As a result of investors shying away from assets perceived as risky, crude oil prices ended last week with a loss of around 6%. However, lower economic growth cutting into energy demand was not the only immediate trigger for the sharp reversal in crude prices..

Stronger USD makes oil more expensive for foreign currency holders

The recent reports show that the US dollar index hitting a fresh two-decade high against a basket of currencies also put an added pressure on crude oil pricing. Although the greenback gave away some of last week’s gains on Monday, it still remains well supported by Fed’s hawkish stance. As crude oil is generally priced in US dollars, stronger greenback typically weighs on purchases in foreign currencies and dampens the sentiment.

Will tight market keep cap on downside?

A weaker economic outlook continues to temper oil demand growth expectations, as the International Energy Agency (IEA) said last week. However, steady demand for light sweet crude in a tight physical market is still presenting a constructive outlook.

Disruptions caused by Russia’s war in Ukraine and unrest in Libya continue to keep global supplies tight. According to IEA, OPEC+’s total oil output may fall as embargoes and sanctions shut in Russian volumes. Although Libyan oil production has recently averaged a better-than-expected 700,000 bbl/day, the country’s overall output capacity remains fragile amid ongoing political tensions. An expected oil demand recovery in China remains another factor. Analysts forecast that a resurgent China will drive demand growth next year.