Oil Dips After Piercing $120 as U.S. Inflation, GDP Worries Bite

© Reuters.

By Barani Krishnan

AiVIF.com -- Oil surged to near three-month highs above $120 a barrel in Monday’s session before turning lower on profit-taking and worries about hurt to the U.S. economy from record fuel prices in a nation already struggling with 40-year highs in inflation.

“The rule of thumb is for every $10 increase in price of a barrel of oil, it shaves one-tenth of a point off GDP,” Mark Zandi, chief economist at Moody’s Analytics said, referring to gross domestic product, the broadest measure of the nation’s economic health.

The average price of gasoline at U.S. pumps hit all-time highs near $4.87 a gallon on Monday, up from $3.05 a year ago. Diesel averaged $5.65 a gallon, up from $3.20 a year ago.

Two schools of thought have emerged over the economic impact of such sky-high fuel prices: one is that demand destruction in gasoline is already happening, with four-week consumption down 2.6% in the third week of May compared with a year ago; the other is that with fuel being an “inelastic” commodity, its demand won’t be hurt as much as the broader U.S. economy.

“I think people will economize on their driving only so much,” Zandi said. “The hit will be to other forms of discretionary spending.”

Economists worry that in its bid to fight inflation, the Federal Reserve will tip the United States into a recession. The economy has been on a weaker trajectory since the start of this year, experiencing a negative growth of 1.4% in the first quarter. If it does not return to positive territory by the second quarter, it will technically be in recession given that it takes just two straight negative quarters to make up a recession.

West Texas Intermediate, the New York-traded benchmark for U.S. crude, settled down 37 cents, or 0.3%, at $118.50 per barrel. 

WTI got to $121 earlier in the day, a peak since the first week of March when it surged to almost $130 after the first Western sanctions on Russia for its invasion of Ukraine. Year-to-date, WTI is up 57%.

Brent, the London-traded global benchmark for crude, settled down 21 cents, or 0.2%, at $119.51 for a barrel meant for August delivery. Earlier, Brent reached a session high of $121.85. It is up 53% on the year.

Oil hit near three-month highs after reacting to Europe’s ban since last week on most Russian oil products as the West widened its actions against Moscow for the war in Ukraine. China’s lifting of Covid restrictions, strong US jobs growth and an ill-timed Saudi hike in the selling price of its crude were also to blame for Monday’s rally, traders said.

The run-up in oil came ahead of the May reading for the Consumer Price Index, due on Friday, which is being watched for further signs of consolidation after its 8.3% growth for the year to April. That was the first time since the CPI reading softened since August, when it showed an annual growth of 5.3%.

Some economists expect the May reading to be a touch softer than April’s, with an annual growth of 8.2%.

Saudi Arabia raised the official selling price, or OSP, for its flagship Arab light crude to Asia to a $6.50 premium versus the average of the Oman and Dubai benchmarks, from a $4.40 premium in June, state oil producer Aramco (TADAWUL:2222) said on Sunday.

The July OSP is the highest since May, when prices hit all-time highs due to worries of disruption in supplies from Russia amid sanctions over its invasion of Ukraine.

The price hike came despite a decision last week by the Organization of the Petroleum Exporting Countries and allies, together called OPEC+, to increase output in July and August by 648,000 barrels per day, or 50% more than previously planned.

But included in the pact was Russia, which has already lost one million barrels in daily production due to sanctions, and countries such as Angola and Nigeria that have repeatedly failed to meet prescribed output targets.

Thus, the net impact of the OPEC+ increase was likely to be around 560,000 barrels daily compared to the scheduled 1.3 million, because most in the oil exporters’ alliance have already maxed out their production, analysts said.

Oil producers are "making hay while the sun shines," Avtar Sandu, manager of commodities at Phillip Futures in Singapore said in comments carried by Reuters.

Sandu added that summer driving demand and a resilient job market in the United States, along with the easing of Covid lockdowns in China, were adding to oil’s upside hype.

The only bearish element in oil, if there appeared to be one, was news that Italy's Eni (BIT:ENI) and Spain's Repsol (OTC:REPYY) could begin shipping Venezuelan oil to Europe as soon as next month to make up for Russian crude. The shipments would resume oil-for-debt swaps halted two years ago when Washington stepped up sanctions on Venezuela.

However, the volume that the companies will receive is not expected to be large, those familiar with the deal told Reuters.

“Whichever way you look at it though, both Brent and WTI prices are nearing post-Ukraine highs, stripping at the days of the initial hostilities themselves,” Jeffrey Halley, who oversees Asia-Pacific research for online trading platform OANDA, said in a note emailed to AiVIF.com.

“Returning Venezuelan and Libyan production to Europe and North America, should it occur, will not be material enough in the shorter term to force prices lower,” Halley said. “Refining margins globally suggest that demand for petrol and diesel remain in heavy demand, with the refining logjam in refined products backstopping crude prices.”

Oil is now into a seventh month of a bull run, rising with six weeks of consistent positive closes, and $130 was WTI’s target, said Sunil Kumar Dixit, chief technical strategist at skcharting.com.

“The just-ended week’s long price action has further established strong bullish momentum that targets a retest of the $123 - $124.50 and $127 levels before retest of $130 if the rally gets adequate volume support,” said Dixit.

Stochastics, Relative Strength Index and Moving Average readings were also strongly supportive for a further upside, he added.

For the current week, WTI’s support will be at $115, Dixit said. “Weakness below $111 will put the brakes on the rally and momentum will turn into correction at that point, exposing oil to $100 and below,” he added.