Throughout history, it has been observed that oil prices tend to decline during periods of economic recession in the United StatesThis trend raises important questions about the current state of oil prices as we witness fluctuations in the market, especially as prices frequently dip around $70 per barrel before quickly reboundingThe underlying dynamics of supply and demand in the oil market are stirring considerable debate among analysts and industry experts.

Since 2022, oil prices have seen significant volatility influenced by alternating pressures of supply and demandThis period can be divided into three distinct phasesThe first phase spanned from January 1 to June 8, 2022, during which West Texas Intermediate (WTI) and Brent crude oil prices surged by 60.5% and 56.5%, respectively, both breaking the $120 per barrel mark and reaching levels not seen since 2008. The second phase, from June 9 to September 26, 2022, witnessed a dramatic decline, with prices for both WTI and Brent tumbling 37.2% and 32.0%, respectively

Advertisements

Finally, the third phase, from September 27 to the present, has seen further declines of 8.7% for WTI and 11.8% for Brent.

The initial surge in prices can be attributed to a combination of heightened supply-demand discrepancies in the wake of the pandemic and concerns related to Russian supply shortagesIn contrast, the second phase was marked by fears of an economic recession coupled with the strengthening of the US dollar, which exerted downward pressure on oil pricesMore recently, the clash between supply contractions and decreasing demand has contributed to increased price volatility, with WTI prices finding support near the $70 per barrel mark, indicating a growing divergence in market opinions at these lower price levels.

Historically, the correlation between economic recessions in the US and declines in oil prices has been strong

Advertisements

Since 1990, the US has experienced four significant recessions, and in each instance, oil prices have dropped substantially, typically responding within six months of the economy entering a downturn.

It is noteworthy that WTI crude prices generally align with global oil demand trendsTransportation demand constitutes about 70% of oil consumption, and this demand is relatively inelastic, often remaining stable even during initial phases of an economic downturnAs a result, oil demand tends to lag behind the economic turning point by one to two quartersDuring the early stages of an economic decline, oil demand often remains stable, leading to a prolonged period of market indecision where prices fluctuate within a constrained range.

In past economic recessions, OPEC has frequently adjusted its production levels in response to demand shocks

Advertisements

However, during economic downturns, many oil-producing countries, including Saudi Arabia, experience budgetary pressures that complicate effective implementation of production cutsHistorical data from the recessions of 2001, 2008, and 2020 shows that OPEC has repeatedly lowered its planned production targets — by 5 million barrels per day in 2001, 3.96 million barrels per day in 2008, and 7.45 million barrels per day in 2020. Despite these reductions, actual output often remained above designated levels due to market conditions, with reductions averaging only 2.98 million barrels per day and 3.02 million barrels per day in 2001 and 2008, respectivelyIt wasn't until the disruptions caused by the pandemic in 2020 that substantial compliance with production cuts was achieved.

Presently, some market analysts contend that oil prices might struggle to breach the $70 per barrel support level

• Downward Potential of China Bond Yields
• Bank of Japan's Interest Rate Hike Approaches
• Oil Market Faces New Phase of Inventory Cuts
• Lithium Prices: Navigating Volatility with Hedging
• Strong Revival of Global Tourism

This outlook is grounded in relatively low US oil inventories, which may trigger replenishment needs, coupled with OPEC+'s decisions to reduce output and capital constraints limiting US oil production growth, as well as the implementation of price ceiling measures on Russian oil exportsNonetheless, the medium-term validity of these concepts remains to be fully assessed.

As the US economy appears poised for recession, and with limited elasticity in the recovery of the Chinese economy, the likelihood of significant upward support for oil prices remains mutedLeading indicators suggest that the American economy may be at a “crossroads” between slowing growth and recession, as evidenced by the US Manufacturing PMI new orders index, which has continuously remained below the expansion threshold for eight months following mid-2022, potentially indicating that economic contraction is set to continue

Likewise, while there is some evidence of recovery in Chinese demand, the pace of this recovery has been subdued, and improvements in transportation sectors are notably slowing, further constraining any supportive effects on oil prices.

On the supply side, ongoing high compliance with production cuts is largely attributed to prior unmet capacity constraints, and the effectiveness of any future production constraints remains in questionThe growth rate of US shale oil production has indeed slowed, yet companies remain incentivized to expand their capacities amidst current price conditionsAs of the first quarter of 2023, the capital expenditure growth rate among US oil firms skyrocketed to 30.6%, closely linked to the number of drilling rigs in operationWith a moderate rise in the number of rigs, the supply of US oil continues to increase, reaching a historical high of 9.33 million barrels per day as of May 11, 2023.

Furthermore, the anticipated impacts of price cap measures and export bans on Russian oil have not materialized as expected