WTI finished higher for the second consecutive week. September futures gained $3.92 to settle on Friday at $98.62/Bbl. This week's gain can be partly attributed to a big draw in U.S. crude inventories, adding to a tight supply market that outweighs risks to demand.
However, oil lost nearly 7%, or $7.14/Bbl, this month due to market volatility brought on by fears of an economic downturn. The U.S. economy contracted for a second consecutive quarter in 2Q, with negative implications for oil (and all energy) demand. The Fed may be aiding a continued slowdown and a strong dollar, two bearish factors for crude-oil prices. The central bank increased interest rates by 75 basis points for a second month to combat rising inflation. However, Chair Jerome Powell said that the rate of increase would eventually slow down.
Following a 1.6% loss in the first quarter, GDP fell at an annualized rate of 0.9%. Because energy input is vital to economic output, GDP and crude oil consumption have a good correlation. The recent GDP growth rate is a sign that crude consumption growth could be slowing. Global oil consumption usually grows at around half the economy's rate (4% GDP roughly equivalent to 2% oil demand growth), and we have been warning of the risks posed by a recession. Before COVID, when the U.S. economy last had two consecutive quarters of negative GDP growth (2008–2009), U.S. crude consumption decreased by 2.65 MMBbl/d, while other countries' increases roughly offset the losses.
Although oil-market sentiment has shifted a little more bearish over the past month, we continue to be bullish relative to the forward curve. Many of the bearish items in the market may very well be priced in now. Unless demand is very disappointing, there is a risk that supply growth may not be able to keep up. We believe prices will realize higher than what the current curve indicates.
Even though fundamentals for oil remain quite strong, we do recognize the impact material demand destruction due to a recession could have. We, therefore, still recommend hedging with collars. A collar would allow a price floor to be set to protect against deteriorating prices and allow for upside participation if prices are higher than the forward curve.