Why plunging oil prices are a warning sign of recession

Biggest drops have historically all been linked to economic downturns

Brent and West Texas Intermediate have lost more than 21 per cent from recent peaks on April 2. Getty images

Oil prices plunged on Wednesday, nearing levels seen during the tail-end of the worst of the Covid-19 pandemic four years ago, amid the overall market mayhem caused by US President Donald Trump's tariffs and the resulting trade wars.

The market is increasingly concerned that tit-for-tat tariffs, particularly between the US and China, the world's two biggest economies, could lead to an all-out global trade battle and hurt economic growth severely.

The oil market – considered an engine of the global economy – is “another place to look” to gauge the health of the global economy, said David Bach, president of the International Institute for Management Development.

That's “because it can give you a sense of whether we're headed into a global recession”, he told The National.

Referring to a note from Morgan Stanley on Monday, which said that the 12.5% drop in Brent just between Wednesday and Friday close last week has happened only 24 times in the history – and 22 of them were associated with a recession.

Those are “historic oil drops of the nature that we're seeing right now … so that's a warning sign,” Mr Bach said.

How much have oil prices fallen?

Brent, the benchmark for two thirds of the world’s oil, had slipped 5.71 per cent to $59.23 per barrel by 5.07pm UAE time on Wednesday. West Texas Intermediate, the gauge that tracks US crude, was down 5.98 per cent to $56.02 a barrel.

Each benchmark lost more than 6 per cent at one point during the day.

From its recent peak of $74.95 on April 2 – the day Mr Trump announced the tariffs – Brent has lost nearly 21 per cent, while WTI has retreated about 22 per cent from $71.71.

How low can oil go?

During the Covid-19 pandemic in 2020, Brent at one point slumped to $9.12 per barrel while WTI turned negative for the first time on record at about minus $37.63 a barrel.

Today's levels have not been seen since early 2021, when oil prices were just beginning to stabilise.

Barring an about-turn in US tariff policies, the outlook for the oil market remains negative and prices could potentially go as low as $50 per barrel, Ipek Ozkardeskaya, senior analyst at Swissquote Bank, told The National.

This is because “waning global growth forecasts and disruption to global supply chains justify the decline in oil prices”, she said.

“It’s important to note that the disruption is not expected to print the same amplitude as during the pandemic but uncertainties should keep the pressure to the downside.”

What can be done?

Movements in the oil market have to contend with supply-and-demand dynamics.

While demand “has likely not suffered yet, rising concerns of weaker oil demand over the coming months requires lower prices to trigger supply adjustments to prevent an oversupplied market”, Giovanni Staunovo, a strategist at UBS, told The National, “unless, of course, President Trump reverses the tariff decisions or we get stimulus measures”, he added.

Meanwhile, the Opec+ alliance of oil-producing countries last Thursday announced a larger-than-expected output increase. The group said it will add 411,000 barrels a day to the market next month, rather than 137,000 bpd as earlier announced.

Oil and stock markets plunge as Trump's tariffs rattle investors

01:40

The tariff and trade shocks, darkening economic prospects and rising uncertainty are pressuring commodity prices, Julius Baer, the Swiss banking corporation, said in a note on Wednesday as it trimmed its oil forecast.

The market has been hit by a double whammy: the souring economy and the latest twists in oil politics as the “petro-nations announced plans to accelerate supply hikes next month”, which come on top of a deteriorating demand outlook, the bank said.