On August 27, 2024, oil prices experienced a significant 2% drop, driven primarily by concerns over slowing economic growth in major global economies, including the United States and China. The decline in oil prices followed a three-day surge of more than 7%, which had initially bolstered market optimism. However, fears of reduced energy demand have now taken center stage, leading to a sharp pullback in crude prices.

Market Performance and Economic Concerns

Brent crude futures, a global benchmark for oil prices, fell by $1.88, or 2.3%, to settle at $79.55 per barrel. Meanwhile, U.S. West Texas Intermediate (WTI) crude dropped by $1.89, or 2.4%, closing at $75.53 per barrel. The drop in oil prices was largely attributed to market concerns that slower economic growth in the U.S. and China, two of the world’s largest energy consumers, could dampen demand for crude oil.

Analysts at Ritterbusch and Associates, an energy advisory firm, noted that the price pullback was a “normal and deserved correction” following the substantial $6-per-barrel advance over the previous three days. Despite the decline, the price movement remained within the expected range, suggesting that the market was adjusting after the rapid rise.

Technical Factors Influencing Oil Prices

Technical traders also pointed to the failure of both Brent and WTI contracts to break above key resistance levels around their 200-day moving averages on Monday as a contributing factor to the price decline. The inability to surpass these technical thresholds signaled to traders that the recent rally might be losing momentum, prompting a sell-off.

In addition to the technical factors, U.S. gasoline futures continued to trade near a six-month low, further pressuring the market. The 3-2-1 crack spread, which measures refining profit margins by comparing the prices of crude oil, gasoline, and distillates, remained near its lowest level since February 2021 for the second consecutive day. A lower crack spread indicates reduced profitability for refiners, leading to a potential decrease in crude oil purchases, which in turn adds to downward pressure on oil prices.

Bob Yawger, director of energy futures at Mizuho, explained that if refiners are not making money on gasoline and distillates, they are likely to reduce their crude oil purchases. “The barrels they do not buy will get sent to storage,” Yawger noted, indicating that a buildup in inventories could further weigh on prices.

U.S. Economic Indicators and Oil Demand

In the United States, consumer confidence rose to a six-month high in August, signaling resilience in consumer sentiment despite economic uncertainties. However, Americans have become increasingly anxious about the labor market after the unemployment rate jumped to 4.3% last month, the highest level in nearly three years. The rise in unemployment has led to increased expectations that the U.S. Federal Reserve may cut interest rates next month in an effort to stimulate economic growth.

Lower interest rates typically boost economic activity by reducing borrowing costs for businesses and consumers, which can, in turn, increase demand for oil. However, the mixed signals from the labor market and broader economic indicators have left the market uncertain about the future direction of oil demand in the U.S.

UBS Global Wealth Management has raised its probability of a U.S. recession to 25%, up from 20% previously, citing weak data from the July labor report. The increased likelihood of a recession has further fueled concerns about reduced energy consumption in the world’s largest economy.

Global Economic Slowdown and Oil Demand

The economic challenges are not limited to the United States. In China, the world’s second-largest economy and a major consumer of oil, economic growth has been slowing, leading to reduced demand for energy. Goldman Sachs recently cut its average 2025 Brent crude forecast by $5 per barrel, citing slower demand in China as a key factor. The investment bank now expects Brent prices to range between $70 and $85 per barrel, with an average forecast of $77 per barrel for 2025, down from its previous estimate of $82.

China’s economic slowdown has been attributed to a combination of factors, including a property market downturn, weaker industrial production, and subdued consumer spending. The country’s struggles to rebound from the pandemic have had a ripple effect on global oil demand, as China is a major importer of crude oil.

In Germany, another key economy, the situation is also grim. The country’s economy contracted in the second quarter of 2024, raising concerns about the broader Eurozone’s economic health. Germany, as Europe’s largest economy, plays a significant role in the region’s energy consumption. A continued economic downturn in Germany could lead to reduced oil demand across the Eurozone, further pressuring global oil prices.

Geopolitical Tensions and Oil Supply Concerns

Despite the bearish economic outlook, there were some bullish factors in the oil market related to supply concerns. Prices had risen strongly in the days leading up to the decline due to the potential shutdown of Libya’s oil fields, which threatened to reduce the country’s output of approximately 1.2 million barrels per day. Libya’s oil production has been a source of volatility in the market, as the country’s output is often disrupted by political instability and conflict.

On Monday, the eastern-based administration in Libya announced that all oilfields in the east, which account for almost all of the country’s production, would be closed. The announcement raised fears of a significant supply disruption, contributing to the earlier rally in oil prices.

In the Middle East, tensions also flared following counterattacks between Israel and the Iran-backed Hezbollah group in Lebanon. The situation added to the geopolitical risk premium in oil prices, as the region is a major hub for global oil production and export. However, the market’s reaction was tempered by the fact that Israel had successfully thwarted a large-scale missile attack by Hezbollah, and Iran did not intervene in the conflict. The absence of broader regional escalation helped to ease concerns about a prolonged disruption in oil supplies from the Middle East.

U.S. Oil Inventories and Market Outlook

Traders and analysts are now closely watching the weekly U.S. oil storage data from the American Petroleum Institute (API) and the U.S. Energy Information Administration (EIA), which are due to be released this week. The data is expected to show that energy firms pulled crude from U.S. storage last week for the eighth time in nine weeks.

Analysts project that the crude storage decline for the week ending August 23 was around 2.3 million barrels. If accurate, this would be a smaller withdrawal compared to the decrease of 10.6 million barrels during the same week last year and the average decrease of 6.3 million barrels over the past five years (2019-2023). A smaller-than-expected drawdown in inventories could weigh on oil prices, as it would suggest that supply is more abundant than anticipated.

Looking ahead, the oil market remains at a crossroads, with a mix of bearish economic indicators and bullish supply concerns creating a volatile trading environment. The ongoing uncertainty about the global economic outlook, particularly in the U.S. and China, will likely continue to influence oil prices in the coming weeks. Additionally, geopolitical developments in Libya and the Middle East could lead to further fluctuations in the market, as traders assess the potential impact on global oil supplies.

In conclusion, while the recent decline in oil prices reflects growing concerns about the global economy, the market is far from settled. With key economic data and geopolitical events on the horizon, oil prices are expected to remain highly sensitive to new developments. Investors and traders will need to stay vigilant as they navigate the complex interplay of economic, technical, and geopolitical factors that are shaping the future of the oil market.

Photo source: Google

By: Montel Kamau

Serrari Financial Analyst

28th August, 2024