Oil shortage starts to curb demand

The price of Brent crude oil is up by 475% since its March 2020 low. And when oil prices rise, people start to reduce consumption, leading to increased fears of a recession.

“The oil price says a trans-Atlantic recession is almost nailed on,” says Russ Mould of AJ Bell. “Since 1970, the oil price has doubled year-on-year six times and on four of those occasions the US and UK have gone into recession within the next two years.” At around $116 a barrel, Brent crude is up by 475% since its March 2020 nadir. “Everyone is waiting nervously to see if 2021 makes it five out of six.”

Prices got an extra boost this week as G7 leaders discussed plans to impose a price cap on Russian oil. That may exacerbate existing supply problems. “About two million barrels a day of Russian oil and refined-product supplies” are unable to enter global markets at present because of sanctions, says Myra Saefong in Barron’s. “US production, meanwhile, hasn’t climbed back to pre-Covid-19 levels” because of “pandemic-related labour shortages and supply-chain constraints”.

Don’t expect Opec+ to ride to the rescue either, says Pavel Molchanov of bank Raymond James. The producer group, which includes Saudi Arabia and Russia, underproduced its output target by 2.616 million barrels a day in May. There is “very limited spare capacity in the Middle East, and none outside the Middle East”. Iran has capacity, but its exports are subject to sanctions.

Enthusiastic oil bulls dominate online conversations about energy, says Jared Dillian on Bloomberg. Many “predict oil will rise to $200 a barrel. In fact, call options with a $200 strike price have traded rather briskly in recent weeks”. Yet fears of a recession have seen oil prices fall 7% since they topped $124 a barrel in early June.

When oil prices rise, people start to reduce consumption. “The only constant in financial markets is that when bullish or bearish sentiment becomes crowded, it is usually profitable to go the other way.”

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