Oil Falls to 5-Week Low on Economic Concerns

Oil (CL) prices dropped by around 5% on Tuesday to the lowest level seen in five weeks as government officials in the US debate about the debt ceiling. The catalysts for the move were rising concerns over the strength of the US economy, lingering worries over the debt ceiling, and anticipation for another rate hike by the Fed later today, Wednesday. It was the largest single-day percentage decline in the oil market since January.

WTI prices were down 5.3%, or $4.00 per barrier, and ended the day at$71.66. Brent oil (EB) was also down almost the same amount in dollars, at $3.99, or 5.0% to $75.32 per barrel at the Tuesday close. Over 3.5% of the loss in WTI prices occurred early into Tuesday's session following the release of China's April PMI, which came in lower than expected, to 49.2 from 51.9 in March due to insufficient demand and a high base formed by the rapid recovery of manufacturing in Q1. The non-manufacturing PMI saw an expansion in construction and services, though at a slower pace. In addition to China's PMI, thin trading volumes had an impact on the prices of oil amidst gloomy job openings as they fell to a near two-year low in March in a sign of a weakening labor market.

What's Driving the Market?

The price of oil declined on Tuesday in the aftermath of US Treasury Secretary, Janet Yellen, saying that the government could run out of money in less than a month in the midst of the increasing debt ceiling debate. US President Joe Biden insisted he would not negotiate over the debt limit when meeting congressional leaders next week on May 9 but would instead start "a separate budget process". 

Concern over the US government default added to weaker factory data from the US, as well as softer than expected durable goods orders. As a result, crude prices erased the gains following OPEC+ voluntary production cuts announced at the start of last month, April. 

In line with that theme, the API's report on Tuesday did not manage to turn the price action around despite showing a larger-than-expected drawdown in crude oil inventories. API reported inventories had dropped by 3.9M barrels compared to expectations of a 1.1M drawdown.

Major Oil Producers See Slowing Profits

Aside from these drivers, earnings reports from major oil and gas companies have shown mixed results over the last quarter. Refiners in the US have seen particularly strong results, while companies focused on production have seen profits slipping. Of the major producers, ExxonMobil (XOM) and Chevron (CVX) reported large profits that were at the top of the range of analysts' expectations but lower than the prior year. Specifically, Chevron's net profit was down 40% from its record earnings in the second quarter of last year, whereas ExxonMobil's results were slightly better in comparison, as profits dropped slightly less at 38% during the same period.

Meanwhile, BP (BP-L) reported modestly better earnings during its quarterly report yesterday, Tuesday. However, it cut back on its share buybacks, driving the share price of BP 6% lower as the company would buy back $1.75B this year, compared to $2.75B last year. French rival TotalEnergies (TTE.PA), which kicked off major oil earnings last week, saw a 27% drop in profits, attributed to lower oil and gas prices. Equinor (EQNR.OL) will report its earning tomorrow, Thursday. (Source:CNBC)

What's On the Horizon?

Morgan Stanley (MS) cut its forecast for Brent prices in the third quarter to $77.50 per barrel, which is $12.50 lower than their prior forecast. The investment bank pointed to Russian supplies remaining resilient and that the boost in demand from China's reopening has most likely already happened. The drop in China's manufacturing is seen as a potential sign that the US and Europe might be headed for a recession. 

On the supply side, Iran's oil minister said the country's production was above the 3M barrier per day, which is higher than the 2.4M that it averaged in 2021. Sanctioned countries like Iran and Russia have continued to find outlets for their crude.

The potential for some solidification of crude prices could come from the Federal Reserve, which is expected to pause its rate hiking program after raising rates later on Wednesday. In that scenario, interest rates would peak at 5.25% compared to inflation trending into the 4.0-5.25% range.

Conclusion

Oil prices were steady through the early trading hours of Wednesday after dropping to the lowest level in five weeks on Tuesday. Cooling in the labor market and an expected hike by the Fed later today increased concern of a recession and put downward pressure on crude. Despite China easing its Covid policies and cutbacks to supply by OPEC and its allies, the drop in oil prices suggests investors give more weight to the demand outlook. Is this the right time to start avoiding riskier times?