Earlier this week, Brent crude fell below $100 per barrel for the first time in months. So did West Texas Intermediate. Copper dropped to the lowest in almost two years. It looked like inflation had done its evil deed. A recession was coming, and demand for commodities was about to plunge. And then both oil and copper rebounded. It lasted all of one day, although the price of copper has been fluctuating with the flow of news from China and the prospects of its economy for the rest of the year and the medium term. The latest copper price rebound was, in fact, attributed by some to the possibility that the Chinese government would provide additional stimulus to keep the economy going at a healthy pace.
The rebound in oil, however, was easy to see coming despite the notorious uncertainty of oil markets. And the reason it was easy to see coming was fundamentals. Whatever happens in the speculative market, the fact that the global supply of oil is tight while demand is very much alive and still rising cannot be ignored.
The Financial Times out it quite clearly. In an article from earlier this week addressing the price drop across commodities, the authors said that “Hedge funds have been central to the recent price declines across commodities — selling out of long, or positive, positions in certain commodities and often replacing them with bearish wagers.”
If the big scare of 2020 and 2021 was Covid, this year has two: Russia’s Vladimir Putin and recession. And it is increasingly looking like the latter is overtaking the former in terms of scare value.
Talk about recession is all over the news. Central banks are being targeted with criticism for tightening monetary policy too fast, accelerating recessionary pressure. It was only a matter of time before hedge funds decided to play it safe and start selling out. But, and this is the important bit, this has nothing to do with fundamentals. Fundamentals are why oil was up a day after the dip.
Just how much nothing market price movements have to do with actual demand and supply sometimes was recently highlighted by Wells Fargo. According to the bank’s investment strategy division, the United States, the world’s largest oil consumer, is already in a recession.
“There’s the technical part of the recession, but then there’s the meaningful deterioration in consumption and employment,” Wells Fargo Investment Institute’s senior global market strategist Sameer Samana told Bloomberg this week. “The technical part is a first half story and the brunt of the unemployment and consumption is the second-half,” Samana added.
Inflation, according to Wells Fargo analysts, has proven to be much faster and more broad than initially expected, consumer sentiment has as a result worsened, and businesses are changing their spending plans. But oil demand is still robust as it appears to be across the world, even though some analysts are projecting a decline. According to Citi’s Ed Morse, for example, “Almost everybody has reduced their expectations of demand for the year.” Demand was “simply not growing on an empirical basis to the degree that people had expected,” Morse told Bloomberg TV.
Demand might not be growing per expectations—it would have been a wonder at these prices—but supply is not exactly booming, either, which was what probably motivated Saudi Arabia’s latest price hike for Asian buyers to near-record levels. Sellers don’t tend to hike their prices when they expect demand for their goods to decline.
No wonder, then, that Goldman Sachs, unlike Citi, says that oil could yet hit $140 per barrel, even with all the recession fears swirling around the market. “$140 is still our base case because, unlike equity, which are anticipatory assets, commodities need to solve for today’s mismatched supply and demand,” Goldman’s Damien Courvalin told CNBC this week.
These price projections, both from Citi and from Goldman, do not factor in supply disruptions—the same supply disruptions that just a couple of months ago, even a month ago, held markets captive. The disruptions are mainly expected to come from Russian oil exports, but this may have by now been factored into prices as there are still close to six months until the European Union’s oil embargo enters into effect.
Meanwhile, alternatives to this supply for Europe remain few and far between simply because of the size of Russian oil exports to the continent. This would likely continue having a bullish effect on oil prices, whatever the economic trends. Even if a recession dampens the demand for oil, it would take quite a while for real demand destruction of the kind that Citi says could push oil to $65 per barrel.
Recession fears have solid foundations. There is little doubt about it. Commodity fundamentals, however, not only in oil and gas but in agricultural commodities and metals, have not changed just because hedge funds have suddenly started worrying about a recession. They are still tight. And this is putting a floor under prices that will remain there as long as supply remains tight.
