Oil Market Rollercoaster Continues To Cause Economic Pain

Global oil prices are falling, continuing their recent downward momentum, and sinking below $100 a barrel for the first time in three weeks, as China suffers another Covid-19 surge and returns to lockdowns that will curtail demand.

Oil’s decline has helped ease inflation fears in markets. However, the reprieve of cheaper oil may be short-lived, as falling prices indicate the market has not fully realized the potential impact of lost Russian barrels on global supply. Inflation concerns still dominate broader financial market activity.

The market is looking ahead to the two-day U.S. Federal Reserve meeting that kicks off today. The Fed is expected to tighten monetary policy, which should strengthen the dollar and push oil prices down.

Historically, the price of oil is inversely related to the price of the U.S. dollar. The explanation for this relationship is based on two well-known premises. A barrel of oil is priced in U.S. dollars across the world. When the U.S. dollar is strong, you need fewer U.S. dollars to buy a barrel of oil.

The oil price correction from $130 a barrel to now nearly below $100 a barrel in a week reflects a number of signals from the market.

China’s oil demand risk is real. It has been experiencing its worst Covid outbreak in two years, since the original Wuhan outbreak. It is estimated that a severe lockdown in China could put 500,000 barrels a day of oil consumption at risk.

China shows no signs of backing off its controversial “zero-tolerance” Covid-19 policy. This is deflationary in the short term as less money is pumped into the economy and less oil is consumed, but on a global scale, it creates inflationary supply-chain issues as manufacturing and transport hubs lockdown.

Indeed, these Covid-19 economic disruptions in China, the world’s manufacturing hub, have been responsible for many of the supply chain issues experienced in the global economy over the past two years. Once again, they will reverberate with knock-on effects in the U.S., Europe, and other developed economies.

China’s woes go beyond oil demand, too, and this Covid-19 outbreak is just one among a host of threats to the Chinese economy.

The housing market bubble and economic swings have long been signaling a real risk to GDP.

Inflationary risks persist, especially in the energy sector, recently validated by China’s plea with refineries to suspend April’s gasoline and oil exports to guarantee domestic demand and quell prices.

Trading across markets is getting increasingly volatile, and the dependence on algorithmic trading systems can turn a micro signal into a sweeping cascade price impact – an occurrence that is happening with increased frequency amid the fog of war in Ukraine and financial market uncertainty.

The U.S. call to ban Russian oil has so far been unanswered, with the exception of the U.K., which, like America, uses little Russian fuel.

Without Europe formally pledging to cut back on its nearly 4 million barrels per day of Russian crude imports, the Russian supply risk that shot oil prices up towards $130 a barrel has been temporarily mollified.

The disruption to Russian petroleum exports – both crude and refined products – is now estimated at 3 million barrels a day. That’s about 1.6 million barrels a day of crude and 1.3 million barrels a day of products.

But predictions that the total for Russian supply disruptions could surge to 5 million barrels a day have not yet materialized. Such a disruption would – and still could – put oil on a path to $150 a barrel or higher.

Traders and refiners remain wary of Russian oil, but it continues to flow, and this trade could pick up as buyers get more comfortable with the idea of handling Russian crude or as Russia gets better at “disguising” its crude – much like Iran has done under sanctions – so that the origin of the barrels becomes less of a problem for buyers.

China and India, two of the world’s three largest oil importers alongside the U.S., continue to buy Russian crude, for example.

U.S. inflation is also in the spotlight, and the expected decision at tomorrow’s Fed meeting to raise interest rates has been slowly strengthening the U.S. dollar and putting downward pressure on oil prices.

Asia and Russia are already showing jet fuel demand distress as both have seen severe downward trends in aviation since the middle of February, Russia due to sanctions but China due to the pandemic. Jet fuel demand has been the last of the oil products to recover to pre-pandemic levels, and the Ukraine war and resurgence of Covid-19 in China means that recovery will be further delayed.

A Chinese shift away from its zero-tolerance Covid-19 policy would signal less risk to oil consumption due to lockdowns in the short term, and new breakouts would be less of a deflationary lever on oil prices. But that doesn’t look to be in the cards.

In short, geopolitics continues to define day-to-day market movements – with the oil price now inversely correlated to market sentiment.

The consensus financial market prediction for 2022 was for muted but stable growth. However global economies are currently experiencing a significant negative shock due to inflation, rising interest rates, war and resurgent Covid.

The reason most expected lower economic growth in 2022 was due to markets having largely factored in the steady recovery already made in 2021 after the lockdown. But substantial new challenges have since emerged, which threaten a significant downturn.

Apart from extremely high inflation, the Russian war on Ukraine, sanctions, and resurgent Covid cases continue to significantly impact markets.

China faces a new Covid-19 outbreak, with cases hitting a two-year high and sending millions into lockdown. Risk assets have retraced significantly, and Nasdaq is now technically in the bear market territory. Investment accounts have taken a big hit, with few sectors but energy showing gains in 2022.

U.S. inflation hit a fresh 40-year high of 7.9 percent in February – before Russia’s invasion of Ukraine and the subsequent oil price spike. That means things are about to get worse for Americans in the coming months, with gasoline pump prices already at record highs of over $4.30 a gallon.

Inflationary pressures have been building in America over the past year, but that has not stopped President Biden from blaming Americans’ mounting economic pain on Russian President Vladimir Putin.

It’s impossible to ignore that Biden’s $1.9 trillion stimulus package in March 2021 was a major factor in the jump in living costs for Americans over the past year. The coronavirus stimulus package was excessive and unnecessary – even Democrats like former Obama Treasury Secretary Lawrence Summers and treasury official Steven Rattner have said as much.

Biden is also wrongly blaming Corporate America for price gouging to explain higher costs. But corporate greed does not explain the hike in prices for energy, food, automobiles, housing, or other goods or services.

In energy, specifically, Biden’s unrelenting focus on climate change has promoted an anti-fossil fuel position that doesn’t square with his new push to increase domestic oil and gas production to help reduce high energy prices. Actions speak louder than words, and Biden has blocked oil and gas pipelines, tried to halt oil and gas leasing on federal lands, and aggressively pushed a clean energy agenda focused on renewables even though oil and gas demand is expected to keep growing for at least the next decade.

U.S. producers are doing all they can to increase output and relieve high prices, but these are privately owned companies with responsibilities to their investors. And right now, those investors are worried about Biden’s climate agenda and how it could impact the U.S. oil and gas sector. Those concerns help contain investment plans in new oil and gas projects, which constrains supply.

Biden’s lack of understanding of the problems immediately at hand for Americans was on display with his promotion of the Build Back Better Act, which fortunately failed. The country doesn’t need another $3.5 trillion in spending on Democratic pet projects like windmills and solar panels when inflation is already through the roof.

Geopolitics will continue to define day-to-day market movements, and investors are grasping on any signs of easing tensions to get invested into markets. But finding such daylight in this environment could be elusive.