Oil Prices Are Going Up for All the Wrong Reasons

Oil prices have been rallying lately, going from $68.00 per barrel on December 12, 2023, to $80.00 per barrel today; a 17.6% gain in less than three months. Superficially, this could look like a sign of economic strength to some observers and oil inventory shortages to others or both. In fact, neither explanation is correct.

As explained here, oil prices are going up for two different reasons that serve to reinforce each other. The first reason has to do with geopolitical risk. Houthi rebels operating in Yemen near the entrance to the Red Sea (and, by extension, the Suez Canal) have shut down most shipping traffic through that passage. One cargo ship was recently sunk, and others have been hit with drones and missiles. Shipping traffic, including oil tankers from the Persian Gulf headed to Europe, has been re-routed around the Cape of Good Hope. The oil keeps moving, but it takes longer and is far more expensive to transport.

The other reason is simple market manipulation. OPEC+, which includes Saudi Arabia and Russia (two of the three largest oil producers in the world), have agreed to extend existing production cuts from prior quotas through the end of June. This is a sign of global economic weakness, not strength.

Saudi Arabia needs the money to balance its budget and continue its economic development. Russia needs the money to replace frozen assets and maintain the War in Ukraine. Both are willing to sacrifice some volume to achieve slightly higher prices.

Still, global economic growth is slowing with recessions in Germany, Japan, the EU as a whole, and the UK. Growth is also dropping precipitously in China. Those economic conditions will grow worse, meaning OPEC+ will have to resort to further output cuts to keep prices from collapsing to the $40.00 per barrel range. That may happen anyway.

These complementary forces – geopolitical supply disruption and market manipulation – will continue, but slower economic growth will trump them both. Oil prices will head lower by mid-year, and that’s not good news for anyone. It’s a sure sign of recession.

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