Oil prices are likely to end their seven-week winning streak as the market faces headwinds from China’s weakening economy and the prospect of higher interest rates in the US. The two factors could dampen the demand for oil and weigh on its prices in the coming weeks.
China’s economic woes pose a risk to oil demand
China, the world’s second-largest oil consumer, has been struggling with a series of economic challenges, including a property crisis, power shortages, supply chain disruptions, and a resurgence of COVID-19 cases. These have taken a toll on the country’s growth momentum and industrial activity, which are key drivers of oil demand.
According to the latest data from China’s National Bureau of Statistics, the country’s gross domestic product (GDP) grew by 4.9% year-on-year in the third quarter of 2023, down from 7.9% in the previous quarter and below market expectations of 5.2%. The industrial production index, which measures the output of factories, mines, and utilities, rose by 3.1% year-on-year in September, the slowest pace since February 2020 and well below the forecast of 5.8%.
The slowdown in China’s economy has also affected its oil imports, which fell by 8.8% year-on-year in September to 10.66 million barrels per day (bpd), the lowest level since May 2020, according to data from China’s General Administration of Customs. The decline was partly due to maintenance at some refineries and lower crude oil quotas for independent refiners.
However, China did make a rare draw on its crude oil inventories in July, the first time in 33 months it has dipped into storage, according to data from the Joint Organisations Data Initiative (JODI). This suggests that the country’s domestic demand for oil remained relatively robust despite the external challenges.
US Fed signals tighter monetary policy amid inflation concerns
The US Federal Reserve (Fed), the central bank of the world’s largest economy and oil consumer, has also signaled its intention to tighten its monetary policy amid rising inflation pressures and strong economic data. The Fed’s policy stance could have a significant impact on the global oil market, as it affects the value of the US dollar, the interest rates, and the economic growth.
On Wednesday, October 13, 2023, the Fed released the minutes of its September meeting, which showed that most policymakers agreed that it would be appropriate to start reducing the pace of its monthly asset purchases “in coming months” if the economy continued to make progress toward its goals of maximum employment and price stability. The Fed has been buying $120 billion worth of Treasury bonds and mortgage-backed securities every month since March 2020 to support the economy during the pandemic.
The Fed’s tapering plan was reinforced by a series of upbeat economic data from the US in the past week, including retail sales, jobless claims, and industrial production, which all beat market expectations and suggested that the economy was recovering from the Delta variant-induced slowdown in August. The data also indicated that inflation remained elevated, as consumer prices rose by 5.4% year-on-year in September, matching the highest level since 2008.
The market expects that the Fed will announce its tapering decision at its next meeting on November 2-3, 2023, and begin to scale back its asset purchases in December or January. The Fed has also hinted that it could raise its benchmark interest rate sooner than previously anticipated if inflation persists. The Fed funds futures market currently implies a 76% probability of a rate hike by June 2024, up from 58% a month ago.
The prospect of a tighter monetary policy from the Fed could put downward pressure on oil prices by strengthening the US dollar, which makes oil more expensive for buyers using other currencies. It could also increase the borrowing costs for oil producers and consumers, and potentially slow down the economic growth and demand for oil.
Oil prices remain supported by tight supply and strong demand
Despite these headwinds, oil prices have remained relatively resilient so far, as they are still supported by tight supply conditions and strong demand recovery in some regions. The global oil market has been in a deficit for most of this year, as the production cuts by OPEC+ (the Organization of Petroleum Exporting Countries and its allies) and other factors such as US shale discipline, Iranian sanctions, and natural disasters have limited the supply growth.
At the same time, the demand for oil has rebounded from the pandemic-induced slump last year, driven by robust consumption in North America, Europe, and parts of Asia. According to the International Energy Agency (IEA), global oil demand is expected to grow by 5.2 million bpd in 2021 and another 3.2 million bpd in 2022, reaching pre-pandemic levels by mid-2022.
The supply-demand imbalance has pushed oil prices to multi-year highs in recent weeks, with Brent crude, the international benchmark, reaching $86.10 a barrel on October 14, 2023, the highest level since October 2018. WTI crude, the US benchmark, also climbed to $83.75 a barrel on the same day, the highest level since November 2014.
However, oil prices have retreated slightly since then, as the market has taken some profits and adjusted its expectations for the future. As of Friday, October 15, 2023, Brent crude was trading at $84.12 a barrel, while WTI crude was trading at $80.49 a barrel.
Outlook: Oil prices face uncertainty and volatility
Looking ahead, oil prices are likely to face more uncertainty and volatility in the coming weeks and months, as the market balances the conflicting forces of supply and demand. On the one hand, the supply side could remain tight, as OPEC+ has been cautious in increasing its output amid the pandemic uncertainty. The group has agreed to raise its production by 400,000 bpd every month until December 2022, but it could revise its plan at its next meeting on November 4, 2023.
On the other hand, the demand side could face some challenges, as China’s economic slowdown and the US Fed’s policy tightening could weigh on the global growth and consumption outlook. Moreover, the COVID-19 situation remains unpredictable, as new variants and outbreaks could pose a risk to the demand recovery.
Therefore, oil prices are likely to remain under pressure in the near term, but they could also find some support from the underlying fundamentals of the market. The IEA has estimated that the global oil market will remain in a deficit of 1.5 million bpd in the fourth quarter of 2023, implying that the demand will still exceed the supply by a significant margin.