Oil prices surge on tight supply but recession fears loom

Opec+ meets on June 30 and is expected to stick to a plan to slightly increase production in July and August

Oil prices continued to rise amid supply concerns. In the US, President Joe Biden has suggested a tax holiday for petrol and diesel. Bloomberg

Oil prices surged on Friday, supported by tight supply, but they posted their second weekly decline on concern that rising interest rates could push the world economy into a recession.

Brent, the benchmark for two thirds of the world's oil, settled 2.79 per cent higher at $113.1 a barrel at the close of the trading session on Friday. West Texas Intermediate, the gauge that tracks US crude, was up 3.21 per cent at $107.6 a barrel.

“The prospect of a recession has made waves across financial markets, and commodities haven't been immune,” Craig Erlam, a senior market analyst at Oanda said.

“Oil prices have undergone quite a significant correction over the last couple of weeks as traders adapt to the increased recession risks, one of the few things that could partially address the imbalance in the market.”

Recession fears are growing around the world amid the Ukraine conflict, the coronavirus pandemic and rising interest rates.

This month, the US Federal Reserve raised its target interest rate by three quarters of a percentage point in an effort to tame rising inflation.

The rate increase was the biggest by the US central bank since 1994 and was delivered after recent data showed little progress in its inflation battle.

The World Bank, as well as the International Monetary Fund, also lowered the growth forecast for the global economy this year as a result of Russia’s military offensive in Ukraine and the pandemic.

The global economy is “teetering on the brink of recession” as the war in Ukraine, Covid-19 lockdowns in China and a hawkish US Federal Reserve weigh on activity worldwide, the Institute of International Finance said in a report last month.

The World Bank forecasts the global economy will grow 2.9 per cent this year lower than the 3.2 per cent projection it issued in April, while the International Monetary Fund expects it to grow 3.6 per cent, down from its previous 4.4 per cent estimate in January.

“Risks remain more tilted to the upside as a result of the tightness in the market but if we continue to see recession risks rise around the world, that could change,” Mr Erlam said.

The oil market continues to remain tight amid supply concerns due to the Ukraine crisis. Russia is one of the top crude producers, accounting for about 10 per cent of the world’s energy output, including 17 per cent of its natural gas and 12 per cent of its oil.

Last month, the EU agreed to ban most of Russia’s oil imports by the end of the year following a move by the US and the UK. Underinvestment in the energy sector is also affecting the supply of oil in the global markets.

“Oil has buckled as hard landing recessionary angst rattles markets, while the US administration has stepped up its fight against elevated energy inflation by calling for a tax holiday on gasoline,” Ehsan Khoman, director of emerging markets research for Europe, the Middle East and Africa at MUFG Bank said.

“Beyond the recessionary fears, however, soaring refining margins continue to underscore extremely tight oil products markets, which matters profoundly for global central banks given it’s what ultimately the real economy consumes.”

On Wednesday, US President Joe Biden called on Congress to enact a three-month federal petrol and diesel tax holiday and also urged states to provide more relief for drivers by suspending their state fuel taxes, as prices across the country continue to hit new highs.

US crude refining capacity is running at a monthly average level of 96 per cent in June and has fallen by about 1 million barrels a day since early 2020 because several refineries were closed or converted, according to the US Energy Information Administration.

“This week hasn’t been good for oil traders,” Naeem Aslam, chief market analyst at Avatrade said. “Basically, traders and investors are concerned that a slowing global economy would have a negative influence on oil demand.”

Opec and its allies are also unwinding record output cuts put in place in 2020 and are boosting supply in the market.

“We know that Opec is going to increase its planned production during their meeting. So, by the end of August, we would have all the supply back on the market,” Mr Aslam said.

This month, the Opec+ super group decided to increase its July and August output to 648,000 barrels a day amid supply shortages. The group will meet on June 30 and is expected to stick to a plan to only slightly increase oil production in July and August.

“Although there is no agreement on by how much each member will increase oil production after September, there is some general consensus to increase it only gradually,” Mr Aslam said.

“What is worrying the most is the situation after December this year as it is then that any member of the Opec member can pump as much oil as they want, and that could change the oil supply and demand equation altogether.”