Earlier this week, Brent oil fell below $100 a barrel for the first time in months. So did West Texas Intermediate. Copper fell to its lowest level in almost two years. Inflation seemed to have done its evil work. A recession was looming and demand for raw materials was about to drop. And then oil and copper rebounded. It lasted a full day, although the price of copper fluctuated with the flow of news from China and the outlook for its economy for the rest of the year and in the medium term. The recent recovery in the price of copper has actually been attributed by some to the possibility that the Chinese government will provide additional stimulus to keep the economy on a steady pace.
Oil’s recovery was easy to see, however, despite the notorious uncertainty of oil markets. And the reason it was easy to see coming was the fundamentals. Whatever happens in the speculative market, one cannot ignore the fact that the global supply of oil is limited, while demand is very much alive and continues to grow.
The Financial Times puts it quite clearly. In an article earlier this week on the commodity price decline, the authors said that “Hedge funds have been central to recent commodity price declines – selling off long or positive positions in certain commodities and often replacing them with bearish bets. “
If the big fear in 2020 and 2021 was Covid, this year there are two: Russia’s Vladimir Putin and the recession. And increasingly, it looks like the latter is outstripping the former in terms of creepy value.
Talk of a recession is all over the news. Central banks have come under fire for tightening monetary policy too quickly, accelerating recessionary pressures. It was only a matter of time before hedge funds decided to play it safe and started selling off. But that’s the point, it has nothing to do with the basics. The main reasons are why oil rose the day after the decline.
How market price movements sometimes have nothing to do with actual supply and demand was recently highlighted by Wells Fargo. According to the bank’s investment strategy department, the United States, the world’s largest oil consumer, is already in recession.
“There’s the technical part of the recession, but there’s also the meaningful deterioration in consumption and employment,” Samir Samana, senior global market strategist at Wells Fargo Investment Institute, told Bloomberg this week. “The technical part is the first half of the story, and the brunt of unemployment and consumption is the second half,” Samana added.
Inflation, according to Wells Fargo analysts, turned out to be much faster and larger than originally expected, as a result of which consumer sentiment worsened and companies changed their spending plans. But oil demand is still steady, it seems, around the world, although some analysts are predicting a decline. According to Citi’s Ed Morse, for example, “Almost everyone has lowered their demand expectations for the year.” Demand “just hasn’t been growing on an empirical basis to the extent that people expected,” Morse told Bloomberg TV.
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Demand may not be growing as expected – it would be a miracle at these prices – but supply isn’t booming either, which is likely what motivated the recent surge in prices in Saudi Arabia for Asian buyers to near-record levels. Sellers are reluctant to raise their prices when they expect demand for their goods to decrease.
Little wonder then that Goldman Sachs, unlike Citi, says oil could still reach $140 a barrel, even with all the recession fears hovering over the market. “$140 is still our base case because unlike stocks, which are pre-assets, commodities have to solve today’s supply-demand mismatch,” Goldman’s Damien Courvalin told CNBC this week.
These price projections, from both Citi and Goldman, don’t take into account supply disruptions – the same supply disruptions that just a few months ago, even a month ago, kept the markets captive. The disruption is expected to come mainly from Russian oil exports, but this may already be factored into prices as the European Union oil embargo still has nearly six months to go into effect.
Meanwhile, alternatives to this supply for Europe remain few and far between simply because of the size of Russian oil exports to the continent. This is likely to continue to have an upward effect on oil prices regardless of economic trends. Even if the recession reduces demand for oil, it will take a long time to really destroy demand of the kind that Citi says could push oil to $65 a barrel.
Fears of a recession have solid foundations. There is no doubt about it. But the commodity fundamentals, not only in oil and gas but also in agricultural commodities and metals, haven’t changed just because hedge funds suddenly started worrying about a recession. They are still tight. And that’s putting a floor below prices that will stay there as long as supply is limited.
By Irina Slav for Oilprice.com
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