Last week, Brent crude fell below $70 for the first time since Dec 2021, adding to concerns that global economic growth could be softer than expected. Or perhaps it reflects problems in China’s economy more than anything else. Traders are commenting that the path of least resistance is a lower oil price given negative seasonality. Indeed, oil prices suggest traders are pricing in a demand slowdown that is similar to a mild recession.
There are some troubling signals in the oil market and a recession-like scenario “is not entirely to be dismissed,” said Martijn Rats, commodity strategist at Morgan Stanley.
Crude oil futures have declined precipitously in September, with Brent and US crude oil posting their worst weeks since October 2023. Brent and US crude are both down more than 15% for the quarter. The global benchmark was trading below $70 per barrel last week, and the decline in prices “has been both quicker and sharper than we expected,” Rats said.
Crude oil over the last 12 months
Source: Trading Economics
Why does the oil price matter?
Oil prices and energy – commodities in general for that matter – naturally impact inflation as key inputs in production as well as directly impacting CPI through commodity sensitive consumer products.
They also indirectly tell us things about inflation (and growth) in that commodity prices are influenced by demand and hence the broader macroeconomic cycle, e.g., rising commodity prices reflect stronger economic conditions.
So lower oil prices are likely to lead to lower inflation through direct effects, but it also speaks to the bigger picture issue of recession risk, which is increasingly coming into focus given the move in the yield curve, unemployment rate, and impending US Federal Reserve pivot to rate cuts.
Morgan Stanley is forecasting a surplus of about 1 million barrels per day in 2025. The investment bank has cut its Brent forecast to $75 from $80 previously for the fourth quarter, with the global benchmark remaining at that level through the end of 2025.
Demand
The oil market appears to be expecting a substantial deterioration in demand conditions, probably through recession-like demand weakness, or a combination of soft demand with increasing supplies from OPEC. The drop in oil prices has coincided with falling expectations of growth coming out of China, with achieving its target of 5% looking increasingly unlikely.
Crude oil inventories in developed economies are expected by markets to increase substantially, adding to price pressures. Over the past five US recessions, these stockpiles built on average by 150 million to 220 million barrels. This crude inventory increase in developed economies would imply a 375 million barrel stockpile build worldwide, or 1 million barrels per day across an entire year, according to Morgan Stanley.
Supply
It may be that increasing supplies, rather than slowing demand due to a recession, are responsible for the inventory build that crude oil futures are signalling. OPEC+ is planning to increase production starting in December, and output in the US, Canada, Brazil and Guyana is robust.
Although rising OPEC output is a key factor behind the anticipated surplus, prices have fallen despite the fact that OPEC+ has made clear the production increases are subject to market conditions.
The 8 OPEC+ countries agreed last week to extend their extra voluntary production cuts for two months until the end of November, underscoring the flexibility of the producer group. Markets still expect three months of OPEC+ production increases but have pushed out the start date to December (vs October previously).
Crude oil over last 4 years
Source: Ed Yardeni
