Oil Slid slightly as the week began while investors weighed the possibility of a global slowdown against the tightness of the market and the possibility of further supply interruptions.
After jumping 2.5% Friday and gaining for the week, WTI crude declined below $108 per barrel. Monday is the Fourth of July holiday, so trading will be light.
The war in Ukraine combined with the western sanctions applied to Russia has boosted oil almost 40% higher than it was last year. At the same time, Vitol Group, the largest independent oil trader, has said it is seeing the high prices begin to eat into demand.
Also of interest to analysts is China’s ending of its Covid lockdowns. China’s economy is slowly beginning to reawaken, increasing its demand for oil. However at the same time, China has discovered 385 local cases of the coronavirus on Saturday, with hundreds of them detected in Anhui province.
The price of oil will likely begin to drop, something indicated by oil markets being in backwardation, where the price of the commodity now is higher than the contract for it in the future. That means traders feel the market is definitely undersupplied right now, so oil will command a premium, however traders are either unsure if demand will be as great in the future, or they suspect it will be less. The different between Brent’s two nearest contracts, or its “prompt spread,” was more than a dollar higher than a month ago, at $3.78.
This is most likely a reflection of the fact the market now accepts it is likely that a recession is approaching, and the economic contraction will substantially reduce the price of oil.
It might also be recognizing that the war in Ukraine will not go on forever. Given Russia’s recent advances in Ukraine, including the taking of Lugansk, and the widely documented inability of Ukraine to field fully trained troops (one account said only 20% of Special Operations forces had ever even fired a weapon before their first combat deployment), it seems as if the Ukrainian forces could collapse at any moment, bringing the war in Ukraine to an end. If that happened, it is possible Europe would quickly normalize relations, to begin Russian gas flowing again. Once relations are normalized, the price of oil would likely collapse rapidly as well.
And if the price of oil collapsed, inflation would diminish absent any rate hikes, the fear of recession would abate, and the Fed’s rate hikes would suddenly become considerably more tame.
The truth is much of what we see in today’s market is due to the war in Ukraine. Were it to end suddenly, the entire market could look vastly different within a week.
