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Market Insights

Oil supply shortages vs recession

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What a week it’s been in global markets!! The Fed went big with 75bps, and even the Swiss National Bank surprised everyone by hiking 50bps. The Bank of Japan held strong with their low rate policy and yield curve control however.

So, higher interest rates are supposed to slow economic growth by shrinking aggregate demand and generally getting people to be more cautious about spending. Central banks call it “slowing economic activity”, while the rest of us call it “the path towards recession”.

At the Fed press conference Chair Powell was asked about the potential outcome of the largest single rate hike since 1994, he replied: “We’re not trying to induce a recession now, let’s be clear about that,”

They might not be trying to, but history suggests that’s the most likely outcome if rates continue to rise…

Recession = Oil lower?

This is the thing. In theory, a recession should reduce oil demand and bring oil prices down. Basically, if people have less money to spend, they’ll make fewer journeys, take less holidays…. Or they buy fewer goods, which means fewer delivery trucks on the road. And the companies that make those goods reduce output because of the slower demand and so the effect ripples throughout the global economy.

Recession concerns are nothing new. These warnings have been circulating for a few months already, but it’s only this week that bond markets have started to blink, with early signs of potential reversals on the charts.

Oil, however, still looks resilient.

Oil Brent

A dip down from the highs, with a peek below the 20 day moving average and support just under 114, before closing back above. The recent momentum may be slowing (blue trendline vs green trendline) but there’s little to suggest that oil prices are heading lower.

Russian energy minister Novak told the St Petersburg International Economic Forum that he sees higher prices ahead:

"In principle, I don't rule out that oil prices may be $150/b by the end of the year, maybe even higher. Everything depends on logistics,"

The International Energy Agency (IEA) report was released this week too. The organisation sees oil demand growing by 2.2 million b/d in 2023 vs 1.8 million b/d growth this year. And they don’t think supply will keep pace..

"OPEC+ capacity constraints set the stage for 2023, when global oil supply will struggle to keep pace with demand”

"While non-OPEC+ continues to power ahead, OPEC+ would have to further deflate its shrunken capacity cushion to keep the implied balance from tipping into deficit,"

"In that case, spare capacity would shrink to just 1.5 million b/d, the lowest level in recent history,"

OPEC’s own report this week forecasts healthy demand through the end of 2022:

"Inflationary pressures are likely to persist and it remains highly uncertain as to when geopolitical issues may be resolved. Nevertheless, oil demand is forecast at healthy levels in the second half of this year."

Even though much has been made of President Biden’s upcoming visit to Saudi Arabia, there’s no guarantee that the Saudis have enough spare capacity (or the motivation?) to sufficiently ramp up production.

The simplest solution, according to OPEC Secretary General Mohammed Barkindo, is for the US to increase domestic production.

"...the US domestic industry, in our opinion, the shale basins are one of the low-hanging fruits that the world can easily tap for additional supplies in the months and years to come."

Barkindo blamed environmental policy for stifling investment too.

"We have not been able to expand this capacity at the level that will meet current and future demand because of a lack of adequate and predictable investment in this industry,"

The fastest solution would be for the US government to provide a stable policy which would incentivise large shale investment across a long enough timeframe to turn a profit.

But this would be at odds with the clean energy platform Democrats have pushed, and policymakers fear that investment into oil and gas production now would disincentivize investment into clean energy products for the future.

If this conflict isn’t resolved, even a recession might not be enough to pull oil prices down.

Not investment advice. Past performance does not guarantee or predict future performance.

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