A global economic contraction will take oil prices lower; good news for consumers and the U.S. Strategic Petroleum Reserve.
Two overwhelming forces are currently working together to contract global economic activity, and, by extension, drive oil prices lower. The headwinds created by these two epic powerhouses will be difficult, if not impossible, to overcome.
First, Central Banks around the world are racing to stymie economic growth by raising interest rates and trimming their balance sheets of holdings thereby removing liquidity from the financial system. The expression “Don’t fight the Fed” evolved for a reason; the US Federal Reserve and its global counterparts can direct and implement market policies that either strengthen or weaken economic activity, and their power over markets is virtually insurmountable. Right now, Central Banks are aggressively trying to control inflation by slowing economic activity; unless they decide to change course it is only a matter of time before they succeed. It’s a pretty safe bet that the global economy will slow and perhaps even shrink before the world’s central banks are done tightening.
Second, and perhaps more frightening, is the inevitable onset of winter in Europe. The loss of Russian natural gas supplies and the looming boycott of Russian crude oil by western nations and their allies will surely result in devastating energy shortages across Europe. Germany is (was) the fourth largest economy in the world and, by its own stunningly shortsighted reliance on Russian gas, will soon be incapacitated by the arrival of cold weather. German industrial production, already greatly reduced by the high cost and limited availability of gas supplies, will grind to a nearly complete halt when the intense cold of January and February arrive. Energy supplies will be directed toward residential and emergency use only; the German economy will contract if not collapse completely, and the ripple effects will be felt throughout the entire global economy. This is not speculation; winter’s cold will arrive, and it’s bite will be fearsome.
Oil prices will be negatively affected by a contracting global economy. It is likely that the price of crude oil, which has remained between $80 and $90 per barrel for quite some time, will break to the downside as economic conditions deteriorate. OPEC has seen this coming, which was the real reason for their latest production cut. Diminished demand for crude will overwhelm the only slightly diminished supply of crude, and crude oil prices will decline. With lower oil prices consumers will benefit, the global economy will benefit and recover more quickly, and the overall the rate of inflation will finally decline significantly. The U.S. Strategic Petroleum Reserve will be refilled with oil priced significantly lower than the oil that was pulled from reserves and sold earlier this year. That’s good news for the U.S. which, as an energy independent nation, will likely suffer the least this winter among many countries around the globe, most especially those in Europe.
It will take time, but as higher interest rates, reduced liquidity, and the cold of winter takes hold, the global economy will contract. It follows that oil prices will decline as well.