Oil Struggles Against Recession Fears; U.S. Crude Climbs While Brent Declines

By Barani Krishnan

Oil investors are realizing that the crude rally driven by Russia and OPEC may not be as resilient as previously thought, especially in light of discussions surrounding a potential U.S. recession.

Since the invasion of Ukraine on February 24, those with long positions in crude oil have largely focused on supply disruptions as the primary driver of energy prices, seeming to overlook demand factors. This mindset has led to a dismissal of concerns about how the worst inflation in the U.S. in four decades could affect oil demand. Additionally, China’s controversial measures to manage new COVID-19 outbreaks—given its status as the largest oil importer—have contributed to skepticism about any potential decline in oil prices.

This week, oil investors continued to demonstrate resolve despite growing discussions about demand destruction, which has intensified as gasoline prices reached nearly $4.50 per gallon and diesel surpassed $6 at U.S. pumps. Following a two-day decline of nearly 10%, crude prices recovered about half of those losses in a single session on Wednesday.

However, the renewed focus of macro investors on the Federal Reserve’s tightening measures and their potential impact on the economy began to adversely affect the oil market on Thursday. After fluctuating throughout the session, the two main crude benchmarks ended the day mixed, highlighting a growing awareness among investors that they could no longer ignore the adverse effects of inflation and recession concerns.

“Oil prices remain highly volatile as the crude demand outlook becomes increasingly uncertain,” stated Ed Moya, an analyst at an online trading platform. “With inflation remaining stubbornly high, global growth concerns are escalating. The risk-off sentiment on Wall Street has resulted in a stronger U.S. dollar, which is putting pressure on oil prices.”

West Texas Intermediate (WTI), the benchmark for U.S. crude, settled up by 42 cents, or 0.4%, at $106.13, having previously dropped by as much as $3 during the session. Meanwhile, Brent crude, the global benchmark, closed down 6 cents, or 0.01%, at $107.45 a barrel after initially rallying by more than $1.

Despite many energy traders remaining focused on the European Union’s potential ban on Russian crude, concerns over supply disruptions seem to be losing momentum, according to Moya. The International Energy Agency cautioned that skyrocketing fuel prices and slowing economic growth are likely to significantly hinder the demand recovery throughout the rest of the year and into 2023.

“In this market environment, oil will struggle if China proceeds with city-wide lockdowns,” Moya commented, noting that investors in crude will need to hope that summer travel—road trips, flights, and cruises—will help sustain demand.

Economists are worried that the U.S. economy, which was beginning to show signs of resilience after the two-year pandemic, might face negative growth again due to the Fed’s tightening measures. Recently, the Producer Price Index (PPI), which gauges wholesale prices, increased by 11% over the year to April—down slightly from an 11.2% rise recorded in the previous month.

A day earlier, the Consumer Price Index (CPI) indicated an 8.3% increase year-over-year for April, compared to an 8.5% rise in March, with fuel and food prices remaining close to all-time highs.

Prior to these reports, the Personal Consumption Expenditure Index (PCE), a key measure for the Fed, had shown increases of 5.8% in December and 6.6% in March. The Federal Reserve, which aims for an inflation rate of just 2% annually, is troubled by these figures and is committed to bringing the PPI, PCE, and CPI readings back to more manageable levels.

In pursuit of this goal, officials at the Fed are considering a potential 75-basis point interest rate hike in June, following increases of 50 and 25 basis points in their May and March meetings, respectively. A 75-basis point adjustment would represent the largest hike since 1994.

Fed Chair Jerome Powell has indicated that a total of seven rate hikes—the maximum permitted within the central bank’s schedule for the year—are planned for 2022, with the possibility of additional hikes in 2023 until inflation returns to the desired 2% rate.