Oil came under heavy selling pressure this week, with Tuesday experiencing a nearly $10/Bbl drop. West Texas Intermediate did finish above the lows, settling Friday at $97.59 – a $7.20 drop since last Friday. Recession fears continue to cloud oil market sentiment.
Wednesday’s consumer price index update didn’t calm investors as data showed 12-month inflation at 9.1%. Energy prices contributed almost half of the amount. High inflation is likely to encourage more Fed action, not less. Federal Reserve Governor Christopher Waller said he supports a 75 basis point hike at the July 26-27 meeting. The U.S. dollar has continued to rise against a basic of currencies, weighing on oil and other commodities. The Bloomberg Commodity Index, which includes energy, grains, metals, and livestock, is now back down to levels seen in late February.
President Biden visited the Middle East this week, touching down in Saudi Arabia on Friday as part of his tour. He is expected to return home without a public announcement on increasing oil supply. However, a New York Times article posted on July 13 said the two sides have an understanding that Saudi Arabia will ramp up production once a current OPEC quota agreement expires in September. The exact amounts are uncertain but Martin Indyk, a former Middle East diplomat, told the Times Saudi Arabia was expected to increase production by about 750 MBbl/d and the UAE would follow suit with an additional 500 MBbl/d, for a combined 1.25 MMBbl/d.
Oil market sentiment has shifted a little more bearish over the past month, but we still remain bullish versus the forward curve. Many of the bearish items in the market may very well be priced-in now. We believe prices will realize higher than what the current curve indicates. In our view, inadequate future supply is more likely than a meltdown of demand. However, we do recognize the impact material demand destruction due to a recession could have and therefore still recommend hedging with collars. A collar would allow for a price floor to be set, to protect against decaying prices, and also allow for upside participation if prices realize higher than the forward curve.