Fall in oil prices. Worst case could be $40 a barrel.

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Oil prices fell again on Friday, hitting their lowest level since December 2021. It is becoming increasingly clear to analysts that bearish economic forces are outweighing the rapid impact of China’s rebound and sanctions against Russia.

West Texas Intermediate crude futures, the US benchmark, fell as low as $65.17 a barrel on Friday, down 4.7% from Thursday’s settlement level. International benchmark Brent crude fell 4.4% to $71.40 a barrel. Both products recovered somewhat around midday, but were still trading down during the day. Brent has lost about 15 per cent in the last 10 days.

Energy Select Sector SPDR ETF
(ticker: XLE) was down 1.5%

Some of the decline appears to be paper losses unrelated to actual oil supply and demand.

“Just as the end of ‘cheap money’ rattled the financial sector, one can only speculate that the similarly high cost of money to carry speculative commodity positions may have contributed to the nearly 13% collapse” in the near term. In oil options, wrote

Bank of America

analyst Doug Leggett.

But it’s also being driven by data showing that people and companies aren’t using as much oil As production is being carried out, more oil is being forced into storage tanks. Globally, 120 million barrels of oil have built up in storage over the past three quarters, as supply exceeds demand. Even after China reopens, analysts do not expect the balance to change for months.

“Oil markets will remain in surplus over the next two months, with fundamental pressures expected to push oil prices up to 46 million barrels through May,” wrote Natasha Kaneva, Head of Global Commodities Research.

JP Morgan
,

Kanaeva had expected Brent to average $89 in the second quarter, but now sees little prospect of prices returning to those levels in the near term. Instead, she sees the price trading between $70 and $80, unless one of two things happen.

The first catalyst will be a change in strategy by OPEC, which has stuck to a production program first known as OPEC+ in October that also includes Russia. At the time, OPEC’s strategy to cut production by two million barrels per day was criticized by the US, as officials said it would drive up prices. US officials worried that higher prices would translate into pain at the gasoline pump and more oil revenue for Russia.

Now, it looks like OPEC was indeed very modest in its cuts, at least from the perspective of oil bulls. The economic situation has worsened enough that OPEC’s current production program could lead to overproduction and prices to fall. There is a chance the group could decide to cut further next week, although OPEC officials have recently dismissed that idea. Caneva thinks the group can cut quotas by about 400,000 barrels per day, a small but important part of the 100 million barrel daily oil market.

The other catalyst will be an announcement by the US government that it will start replenishing the Strategic Petroleum Reserve (SPR), which is at its lowest level in decades. Large oil purchases by the government are likely to increase prices. President Joe Biden said last year that the government would consider purchases when oil was at or below $67-72 a barrel, which would go into effect today.

But the Department of Energy is still selling oil from the SPR because of congressionally mandated sales. Department officials have said that they cannot buy and sell oil from SPR simultaneously due to logistical reasons. However, Biden has said the department could buy oil for the SPR in the future on fixed-price contracts – which would allow the government to buy now under the condition that the oil is delivered in a few months. The department did not immediately respond to questions on whether it would do so.

In the absence of those two catalysts, the path of oil prices may depend on the size of the banking turmoil. If things take a turn for the worse, Kaneva warned that prices would fall sharply, as recessions caused by the financial crisis are two to three times worse for oil than other recessions.

“Historical analysis shows that contagion in financial markets penetrates deeply and over a long period of time into the physical economy, cutting consumer spending and hitting oil demand hard,” she wrote. If the current crisis affects the entire regional banking system, Brent could drop as low as $40.

Write to Avi Salzman at [email protected]