Oil falls after breaking through $120 as inflation and GDP concerns in the United States bite

In Monday’s session, oil rose to near three-month highs above $120 a barrel before falling on profit-taking and concerns about the impact on the US economy of record fuel prices in a country already grappling with 40-year high inflation. “The rule of thumb is that every $10 increase in the price of a barrel of oil subtracts one-tenth of a point from GDP,” said Mark Zandi, chief economist at Moody’s Analytics. GDP is the broadest indicator of the country’s economic health.

On Monday, the average price of gasoline at U.S. gas stations reached all-time highs near $4.87 per gallon, up from $3.05 a year earlier. Diesel was $5.65 per gallon on average, up from $3.20 a year ago. Two schools of thought have emerged regarding the economic impact of such high fuel prices: one believes that demand destruction in gasoline is already taking place, with four-week consumption down 2.6 percent in the third week of May compared to a year ago; the other believes that because fuel is a “inelastic” commodity, its demand will not be harmed as much as the broader US economy.

Economists are concerned that the Federal Reserve’s efforts to combat inflation will push the US into recession. Since the beginning of the year, the economy has been on a downward trend, with negative growth of 1.4 percent in the first quarter. It will officially be in recession if it does not return to positive territory by the second quarter, as it only takes two consecutive negative quarters to cause a recession.

The New York-traded benchmark for US crude, West Texas Intermediate, fell 37 cents, or 0.3 percent, to $118.50 per barrel. “I believe people will only cut back on their driving to a certain extent,” Zandi remarked. “Other sorts of discretionary expenditure will take a blow.” WTI hit a high of $121 earlier today, its highest level since the first week of March, when it soared to nearly $130 following the imposition of the first Western sanctions on Russia for its invasion of Ukraine. WTI is up 57 percent year to date.

Brent, the worldwide standard for crude traded in London, fell 21 cents, or 0.2 percent, to $119.51 for a barrel due in August. Brent had previously hit a session high of $121.85. It has increased by 53% year over year. Oil prices rose to three-month highs as a result of Europe’s ban on most Russian oil products, which went into effect last week as the West escalated its sanctions against Moscow over the Ukraine conflict. Traders blamed Monday’s gain on China’s removal of Covid restrictions, solid US employment growth, and an ill-timed Saudi increase in the selling price of its petroleum.

The rise in oil occurred ahead of the Consumer Price Index’s May reading, which is coming on Friday and will be scrutinized for signs of further contraction following its 8.3 percent climb in the year to April. That was the first time the CPI measurement had dipped since August, when it had increased by 5.3 percent on an annual basis.

Saudi Arabia boosted the official selling price, or OSP, for its flagship Arab light crude to Asia to a $6.50 premium above the average of the Oman and Dubai benchmarks on Sunday, up from a $4.40 premium in June. The July OSP is the highest since May, when prices reached all-time highs due to fears of supply disruptions from Russia as a result of sanctions imposed in response to its invasion of Ukraine.

The price increase came despite OPEC+, the Organization of Petroleum Exporting Countries and its partners, agreeing last week to expand supply by 648,000 barrels per day in July and August, or 50% more than previously planned. However, Russia, which has already lost one million barrels per day owing to sanctions, and nations like Angola and Nigeria, which have frequently failed to fulfil set output objectives, were included in the accord.

As a result, analysts estimate that the net impact of the OPEC+ rise will be roughly 560,000 barrels per day, compared to the planned 1.3 million, because most members of the oil exporters’ alliance have already reached their production capacity. In comments cited by Reuters, Avtar Sandu, manager of commodities at Phillip Futures in Singapore, remarked that oil producers are “making hay while the sun shines.”

Summer driving demand and a solid job climate in the United States, as well as the relaxation of Covid lockdowns in China, are all contributing to oil’s bullish hype, according to Sandu. The only bearish aspect in oil, if there was one, was news that Eni and Repsol could start shipping Venezuelan oil to Europe as soon as next month to compensate for Russian crude. The shipments would restore oil-for-debt swaps that were interrupted two years ago when the US tightened sanctions against Venezuela.

“Should Venezuelan and Libyan production be returned to Europe and North America, it will not be significant enough to cut prices in the medium term,” Halley added. “Global refining margins show that demand for gasoline and diesel remains strong, with the refining glut in refined products supporting crude prices.”

According to Sunil Kumar Dixit, chief technical strategist at skcharting.com, oil is now in its seventh month of a bull run, with six weeks of steady positive closes, and $130 was WTI’s aim. “The recent week’s long price action has built strong bullish momentum that aims a retest of the $123 – $124.50 and $127 levels before retesting $130 provided the rally receives appropriate volume support,” Dixit added. He said that the readings of the Stochastics, Relative Strength Index, and Moving Average were also extremely supportive of additional rise.

WTI will be supported at $115 this week, according to Dixit. “At that time, weakness below $111 will put the brakes on the rally, and momentum will turn into a correction, exposing oil to $100 and below,” he warned.