Why Oil Prices Fell Back Below $70

One of the biggest mistakes I have seen traders make over the years, and to be honest it is also something of which I have been guilty many times in the past, is the desire, need almost, to trade in the “logical” direction on every piece of news. Very often, though, the better trade is to fade the initial reaction when circumstances appear to change. This week, for example, reports surfaced that OPEC+ were going to postpone their scheduled crude output increases for a couple of months. Those reports came out on Thursday, but here is the chart for that day, up until 1 pm.

The news did cause an initial spike, but those gains were quickly given back and by the afternoon, WTI was trading lower than it was before the “bullish” news surfaced. Why is that and, more importantly in many ways, what can we learn from it?

The first thing to point out is that OPEC+ not increasing output wasn’t really “news” at all. It had been rumored for a while and was to a large extent priced in before the stories were published. That is in large part due to the fact that oil has been falling for a few weeks. Three weeks ago, when crude was up around $77 per barrel, I wrote a piece predicting just that. I am not pointing that out to show how smart I am, although you can of course feel free to think that, but rather because the conditions that made that move predictable are still in place.

The last few weeks have not been about the supply side of the pricing equation, important as that is. They have been about some worrying questions around demand, based on what is looking like the increasingly likely chance of a recession in the US, and falling demand in China.

In America, the Fed has refused to cut rates until now despite some evidence of weakness in key economic data such as employment and consumer spending, raising the possibility that they are still squeezing an already tight economy. I am not in the camp that would criticize them for that, as I am old enough to remember the effects of the inflation in the 1970s and 80s, when central banks routinely cut rates too early to avoid the political fallout from a slowing economy. However, truly taming inflation inevitably comes at a price, and it looks as if the time to pay that price is approaching.

Nor are things likely to improve any time soon, at least in terms of the way the market sees US demand. Lest you have forgotten, there is an election approaching, and it seems that whichever side wins, it will be bearish for oil prices. Trump is pro fossil fuels but has said that he will express that support by opening up land for drilling, thus potentially increasing American supply. Harris, on the other hand has, in the past, been a supporter of the “Green New Deal” and while she has recently said that she now doesn’t support a ban on fracking, policies that favor alternatives and discourage oil usage look likely should she win. In other words, a Republican win would mean more supply and a Democratic victory, less demand. Neither is very supportive of oil prices.

In China, the economy contracted last year for the first time in seemingly forever, and while there has been some bounce back from that, 2024 growth will be slower than most anticipated even just a few months ago. Manufacturing output in particular has been slowing, which is bad for oil consumption, and the fact that the country is now a leader in EV production will also serve to reduce demand.

So, what we got on Thursday was “news” that traders had seen coming for a while, and that was not particularly relevant to the dominant factor in oil pricing over the last month or so. It sounded bullish, and the initial reaction indicated that traders thought that way, but the pop was really just a good opportunity to sell a commodity that looks set to continue lower for a while.