When anxiety about a recession combines with one of the most robust physical oil markets ever, what happens to oil prices? | Paragon Alpha

When anxiety about a recession combines with one of the most robust physical oil markets ever, what happens to oil prices?

By Matea Gucec

They fall. Or at least that has been the situation for the past few weeks, and it was confirmed once more on Thursday when both Brent and West Texas Intermediate fell below the levels they had reached before Russia's invasion of Ukraine, which caused an unprecedented interruption in oil exports.

Marwan Younes, president of Massar Capital Management, a hedge fund that manages about $1.2 billion in assets, says: “It’s just what is the most powerful driver at any point in time, and right now I think that economic deceleration is a very powerful pressure on oil markets."

But it doesn't seem like the physical oil market is weak at all.

Due to Russia's invasion of Ukraine, one of the biggest manufacturers may soon be subject to an embargo by the European Union. The North African nation of Libya is experiencing political unrest and a near-halt in supplies. All of that is before even taking into account the persistent underinvestment in oil production on a worldwide scale.

Bulls argue that washout is excessive because it overlooks the current supply crunch. Since late June, Brent futures for immediate delivery have been trading more than $3 above those for the next month, a sign that traders are prepared to pay a premium to get physical barrels. The global standard had never maintained premiums of such scale until Russia invaded Ukraine.

Excellent refining margins have supported the strength of crude. This month, Shell Plc said that it may have earned up to $1 billion from its refining operations in the previous three months. Refiners can afford to pay exorbitant premiums for physical oil since BP Plc's estimated worldwide refining margin increased from $19 in the first quarter to more than $45 per barrel in the second.

But a bigger repricing of the financial markets throughout the world has erased all of that. A measure of the dollar's strength is currently trading at its highest level ever, and everyone from hedge funds to investment banks has been favoring a stronger dollar surge. That's terrible news for developing markets dependent on the dollar, which now account for a larger share of demand than it did during previous economic downturns. Investors have thus become more cautious. The largest since March, or 100 million barrels, in net-bullish Brent and WTI wagers were canceled last week by traders. Over $800 million has been pulled out of the largest long-oil exchange-traded fund since April.

For the first time, countrywide US gas prices last month exceeded $5 per gallon. The country's most recent gasoline demand data were the lowest seasonally in 25 years, and road fuel sales in the UK fell more than 3 percent last week compared to the same period last year.


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