Recession angst vs scarcity fears: Where are crude oil prices headed?

Oil prices sold off over the past days, dropping below USD 110 from above USD 125 mid-June. Recession fears have their grip on markets, but the mood swing is rather one of ebbing optimism than swelling pessimism. We struggle to see lasting scarcity. Russian oil still finds its buyers and the cargoes simply take the longer voyage towards Asia as the latest Chinese trade statistics confirm. Oil prices sold off heavily over the past days, from above USD 125 to below USD 110.

Recession fears seem to dampen the market mood, which is in increasing contrast to the previous weeks dominated by supply concerns. The sentiment setback is not one of swelling pessimism but rather ebbing optimism. While the global economy looks set to leave inflation and rate scares with bruises and scratches, we do not see business activities meaningfully derailed from the ongoing turbulence. Fundamentally, we struggle to observe lasting scarcity in the oil market. Russian oil still finds its buyers, and the supply shortfall seems much smaller than initially feared. Europe’s efforts to wean itself off Russian oil is a story of supply rerouting rather than supply losses, with the cargoes now taking the longer voyage to Asia as the latest Chinese trade data confirmed.

The perception bias persists. While we see how European buying depletes US storage, thanks to timely and accurate data, we do not see how it swells markets in China and India, due to a lack of credible and timely data. If China allowed more oil product exports, its underused refinery capacity could swiftly ease fuel tightness globally. However, the increase of export quotas is a political decision and seems unlikely. This aspect fits some of our more general perceptions.

Today’s elevated oil prices are the result of the post-pandemic’s demand rebound and political constraints, rather than underinvestment. As much as China’s fuel export policy adds to fuel tightness globally, it is the West’s sanctions schemes against Iran and Venezuela and the petro-nations’ slow lifting of production restrictions that crippled oil supplies artificially as of late. The shale business’ ramp up of investments and production shows that capital has not been a lasting constraint, or only very selectively in high-risk emerging markets. More downside to prices can be seen as the mood cycle ebbs and fundamentals ease. However, market conditions remain prone to any further unforeseen additional supply shock.

(The author is Head Economics and Next Generation Research, Julius Baer.)