Citi’s commodity strategists raised many eyebrows in July this year when they said oil prices could collapse to $65 a barrel before the year-end. At that time, crude oil prices were trading comfortably above the $100 handle on fears the West may impose a full ban on Russian oil.
Fast-forward two months, and oil prices were trading below $80 a barrel, prompting OPEC+ countries to deliver a deep production cut in a bid to boost prices. While the near-term spike in prices was secured, oil prices still need to stage a meaningful rally even though winter is arriving in Europe.
Recession Fears Keep Oil Prices Capped
The expectations of increasing U.S. production, coupled with the poor economic activity in China and persisting coronavirus restrictions, continue to prevent oil prices from rallying. Moreover, the fact that the Fed looks committed to continue tightening its monetary policy also weighs on prices.
According to the latest data, U.S. oil production increased to almost 12 million barrels per day in August, the highest level since the coronavirus outbreak. At the same time, China saw a significant slump in factory activity in October, according to an official survey, as fading global demand and the country’s zero-COVID policy continue to weigh on production.
SPI Asset Management’s Stephen Innes said:
“The purchasing managers’ index (PMI) data contracting adds to the post-China congress party blues for oil markets. It is not difficult to draw a straight line from weaker PMIs to China’s COVID-zero policy.
So long as COVID-zero remains entrenched, it will continue to thwart oil bulls.”
China is tightening its rigorous coronavirus restrictions even further in some cities as the number of COVID-19 cases continues to surge. The country’s zero-COVID policy has notably hurt its economic and business activity and oil demand. Crude oil imports in China declined 4.3% in Q1 year-over-year, marking the first annual decline for that period since 2014.
Crude oil prices staged a minor rally on Tuesday on rumors that China is finally considering exiting its zero-COVID policy. China is the biggest crude importer in the world.
Elsewhere, the euro area is heading for an economic recession after data showed that its business activity in October shrank at the fastest pace in almost two years.
Preliminary data from Eurostat showed that eurozone inflation notched another all-time high of 10.7%. The European Central Bank (ECB) reiterated its plans to keep hiking interest rates even if such monetary policy tips the bloc into recession.
Despite the increasing recession fears, the Organization of the Petroleum Exporting Countries (OPEC) increased its forecast for medium and long-term oil demand, adding that $12.1 trillion in investment is required to address the current demand.
U.S. Helping Oil Prices to Stay Balanced
U.S. President Joe Biden is expected to urge Congress to impose tax penalties and other restrictions on oil companies. Biden has already pushed oil producers to hike production instead of using their profits for dividends and share repurchases. In addition, Biden was set to ask oil and gas companies to invest some of their record profits to reduce costs for U.S. families.
Biden’s administration has been using its Strategic Petroleum Reserves (SPR) to address the current supply crisis. The administration discharged around 1.9 million barrels last week as a part of its plan to release a total of 180 million. Biden said he gave the green light earlier this month to release 15 million barrels from SPR sometime in December to tame gas prices.
“But they’re not falling fast enough. Families are hurting,” Biden added.
The SPR has more than half of its reserves at its disposal, totaling more than 400 million barrels. This will allow Biden’s administration to prepare for upcoming releases and “move quickly to prevent oil price spikes and respond to international events.” For context, Exxon Mobil (NYSE:XOM) - one of the world’s largest publicly traded oil companies - typically produces around 800,000 barrels of crude oil per day.
The December release is meant to maintain the oil supply and prevent another spike in gas prices, regardless of future actions by Russia and other bigwigs. On the other hand, Biden’s move is less likely to push down gas prices, noted Jay Hikes, former head of the Energy Information Administration (EIA). Hakes said:
“We’re talking about fairly small potatoes here with putting 15 million barrels into the market, and I think the market was probably expecting that to happen anyway.
I think the overall 180 million has been helpful in getting us through a rough patch. This additional enhancement, I don’t see moving the needle that much.”
Furthermore, Hikes thinks that the move could be considered a response to OPEC+’s action and shows that the U.S. also has the power to move the market.
“I don’t think that the United States can just sit back and take what OPEC did,” Hakes added.
Summary
Oil prices have returned to trade below $90 a barrel after a short-term rally that saw prices hit the highest level since late August. The combination of China’s zero-COVID policy, aggressive central bank tightening, as well as the U.S. using its Strategic Petroleum Reserves to address the current supply crisis is preventing oil prices from driving higher despite deep OPEC+ production cuts announced earlier in October.