Fueled by the war in Ukraine, oil prices had surged above $100 a barrel to levels last seen in 2014. With recessionary prospects, prices have slowly leveled off, but it remains around the $80 mark, a historically high level. A report from the Energy Information Administration showed that stockpiles had dropped by 4.58 million barrels last week. This substantial new drop should have supported the price up. Instead, prices violently dropped. The gains made earlier this month when the OPEC+ countries had agreed to cut supply had evaporated.
A few weeks ago, analysts predicted oil prices would back up to $100. Today, analysts are concerned about prices that could dip back to the $70 mark. Bad economic news is indeed piling up in the West. In the United States, jobless claims have been consolidating upward, suggesting the labor market is finally tightening as companies start to lay off workers. The Leading Economic Indicators published by the Conference Board were also very weak, and the pace of decline implies a recession. This accumulation of harmful data has limited appetite for buying oil, just as it has encouraged investors to rebuy short-term bonds. The two-year yield, particularly sensitive to interest rates and short-term recession risks, has dropped 10 basis points to 4.14%.
Unusually mild temperatures in the major metropolitan areas of the US this winter have eroded the need for fuel, and refiners are now looking for ways to cut costs. Some refiners also fear that demand may need to be stronger to justify additional purchases. The future of oil prices is uncertain, but one thing is sure: the market will remain volatile for the foreseeable future.
Overall, investors have focused on short-term data. The number of trucks traveling on highways in China has significantly decreased recently. In Europe, the diesel premium to crude futures contracts recently plunged to its lowest level in over a year. In the US, demand is projected to contract by 2% in 2023, according to S&P Global. Excluding 2020, when much of the economy briefly stalled, this 2% drop would be the most significant US diesel utilization decline since 2016.
Yet, many elements could signal the risk of oil prices soaring to new highs. OPEC+’s decision, the Iranian-Saudi rapprochement, and the conflict in Ukraine are major geopolitical shifts in oil and a return to the 70s. This is coupled with considerable upside surprises in Chinese economic data that the market has chosen to ignore. China’s GDP grew 4.5% year-on-year in the first quarter, against an expected 4%, while retail sales exceeded 10%.
The converging interests of oil-producing countries and the world’s second-largest economy, which sources oil cheaply from Russia and Iran, could lead to a supply shock. The world would thus face a recession exacerbated by energy price inflation.