Oil prices drop 5% on China demand concerns and fears of global economic slowdown

Futures extend the declines of the previous trading session as recession risk grows

Brent averaged $103.70 a barrel last year, gaining about 10 per cent annually, after jumping 50 per cent in 2021. Reuters
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Oil prices fell more than 5 per cent on Wednesday amid a deteriorating fuel demand outlook in China, the world's largest crude importer, and growing concerns of a global economic slowdown.

Brent, the benchmark for two thirds of the world’s oil, settled 5.2 per cent lower at $77.84 a barrel at the end of trading on Wednesday, while West Texas Intermediate, the gauge that tracks US crude, declined 5.3 per cent to $72.84 a barrel.

Crude futures closed more than 4 per cent lower on Tuesday after the International Monetary Fund's managing director said a third of the world's economies could slide into a recession in 2023.

“Oil prices have tumbled again ... by the uncertain near-term economic prospects for China amid surging Covid cases,” said Craig Erlam, a senior market analyst at Oanda.

"While reliable data is seemingly hard to come by, the view appears to be that there'll be significant disruption in the coming months and then a recovery from around the middle of the year which should then boost demand.

"Despite this, the medium-term prospects still appear quite bullish, especially if China can bounce back strongly later this year and fully transition to living with Covid, like much of the rest of the world. Of course, Russia remains the wildcard in all of this, both in terms of its output and influence within Opec+."

The US dollar was weaker on Wednesday making oil cheaper for holders of other currencies.

The US Dollar Index, a measure of the value of the greenback against a weighted basket of major currencies, was down 0.55 per cent at 103.94 on Wednesday after gaining about 1 per cent since January 1.

The index has declined about 6 per cent over the past three months.

“Crude and brent oil prices are on track to record their weekly losses as investors continue to question a number of important factors that are pinning the demand,” said Naeem Aslam, chief market analyst at AvaTrade.

China's economy is forecast to grow by 4.4 per cent in 2023, after an estimated 3.2 per cent expansion last year and 8.1 per cent growth in 2021, according to the IMF.

A slowdown in China’s economy last year added to global supply chain disruptions and crimped global growth amid renewed Covid-19 outbreaks and the country's zero-Covid approach that led to new lockdowns.

Markets are bracing for minutes from the US Federal Reserve’s December meeting. The minutes offer insights regarding the Federal Open Market Committee’s stance on inflation and overall monetary policy.

“A hawkish tone is unlikely to be positive for oil prices as that would mean a further slowdown in economic growth,” Mr Aslam said.

Last month, the Fed raised its interest rates by 50 basis points to fight inflation and indicated that more increases are planned this year.

It was the seventh time the Fed raised interest rates in 2022. The rates were near zero per cent in March.

Brent averaged $103.70 a barrel last year, gaining about 10 per cent annually, after jumping 50 per cent in 2021, while WTI ended up about 7 per cent last year, after a 55 per cent surge in 2021.

This was the second annual gain for the oil market despite last year's price volatility, which was exacerbated by the Ukraine war that disrupted global supplies.

“Crude prices could struggle here as a strong dollar could be here to stay as investors can’t pass up the yield they are getting in fixed income,” said Mr Moya.

“Manufacturing activity globally mostly appears to be stuck in contraction territory and that might not improve until the end of the quarter.”

In terms of price levels, Mr Aslam said the fact that the crude oil price continues to trade above the important support level of $70 really “differentiates the bull and bear territory”.

UBS expects Brent to trade at $110 a barrel in mid-2023 while WTI is estimated to average $107 a barrel.

China’s reopening may result in oil demand hitting a “record high” in the second half of this year, the Swiss lender said in a research note on Wednesday.

“Meanwhile, Russian oil production should fall in 2023 due to the European Union's embargo on Russian crude and refined products,” UBS strategists said.

An increase in production outside the Opec+ group of countries is expected to be modest given years of underinvestment in new oil and gas projects, they said.

In its December oil market report, the International Energy Agency increased its global oil demand growth estimate for 2023 based on rising crude consumption in India, China and the Middle East.

The IEA expects oil demand to grow by 1.7 million barrels per day in 2023, up from its previous estimate of 1.6 million.

Updated: January 05, 2023, 3:11 AM
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