Is Demand Destruction Behind the Drop in Crude Oil Pricing?

West Texas Intermediate (WTI) crude oil for October delivery traded down nearly 9% early Tuesday at around $36.25 a barrel. While the price recovered a bit, it was still well below the high posted last Thursday of more than $43. If options trading is to be believed, that level may not be seen again until sometime in 2022.

According to AAA, a gallon of regular gas costs $2.22 Tuesday morning, down a penny from a week ago, but up about four cents compared with month-ago prices. Year over year, the price is down by about 44 cents per gallon.

The OPEC+ production cuts apparently had only a modest impact on global prices, and Saudi Arabia has just announced its lowest price in five months on exports to Asia. The Organization of the Petroleum Exporting Countries and its allies have pulled back on production cuts, from around 10 million barrels a day to 7.7 million barrels, adding more barrels to an already bursting global supply.

In the United States, Labor Day marks the end of the summer driving season, and there’s little argument that this year’s driving season was a flop from the demand side. U.S. producers lifted their drilling activity when prices were rising, but now all that’s happening is that more oil will be produced at lower prices.

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Even Brent crude, the international benchmark, traded below $40 a barrel Tuesday morning, down more than 5% for the day.

Fitch Ratings on Tuesday painted an even more downbeat picture. While the ratings firm expects base case prices for both WTI and Brent to rise from previous 2020 estimates of $32 and $35 to $38 and $41, respectively, pricing assumptions for 2021 were left unchanged at $45 for Brent and $42 for WTI.

The news gets worse the further out Fitch looks. For 2022, the firm lowered its price assumptions from $50 for WTI and $53 for Brent to $47 and $50, respectively. For 2023, WTI was assigned an initial price of $50 and Brent an initial price of $55. The firm’s long-term view has been adjusted from a WTI price of $52 down to $50 and a Brent price of $55 to $53.

Fitch said that the reductions “reflect large underutilised production capacities, the extended period of high oil inventory caused by the coronavirus pandemic, falling upstream unit costs and the long-term energy transition.” That may fairly be interpreted as more than just falling demand. A long-term transition points to demand destruction.

In a stress-case scenario, Fitch lowered its long-term assumptions from $50 to $48 for Brent and from $52 to $50 for WTI.

At Tuesday’s price, WTI had dropped by nearly $30 a barrel since January. All the current signals indicate that oil is never again going to reach that level except in periodic spikes caused by black-swan events like storms and conflicts.

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