Crude oil rallies as economic growth continues to decelerate

Oil has rallied sharply in the new year as new US sanctions on the Russian oil industry could impact oil supplies over the next few months. This comes at a time when crude oil inventories were already at critically low levels. However, oil demand has been weakening meaningfully over the past months, indicating a weakening global economy. The recent spike in oil prices, coupled with a rising USD, could accelerate the economic slowdown. 

The upward trend in crude oil that started middle of December accelerated sharply on the back of new US sanctions on the Russian oil industry (see Exhibit 1). 

Exhibit 1: Brent crude oil showed a remarkable rally over the past weeks and finally broke through the 200-day moving average

$/bbl

Source: Goldmoney Research

The white house announced sweeping sanctions on the Russian oil industry on Friday January 10. The new wave of sanctions targets the “shadow fleet” of tankers that moves Russian oil predominantly to Asia, as well as insurers, two oil producers and a host of individuals. The latest sanctions are the most extensive measures imposed by the United States since the invasion of Ukraine. 

And they are likely to have teeth. Even before the latest sanctions have been announced, Chinese and Indian buyers – the main purchasers of Russian crude oil – started showing signs of reluctance to take Russian crude. China's Shandong port declared a few days before the new sanctions were announced that it bans US-designated Russian ships from entry. According to Reuters, of the 33 tankers that were already sanctioned in 2023, 30 no longer move oil. The new sanctions add a whopping 160 vessels. 

We estimate that the tankers moved close to 1mb/d of Russian crude. Those barrels will now have to find new transportation, which poses upward pressure on the global tanker market. 

Previous sanctions had little impact on Russian crude oil exports

Thousand b/d

Source: Goldmoney Research

The new sanctions only come into full effect on March 12. But given that we saw increased reluctance from buyers and ports before they were even announced, their likely effect is probably felt much earlier. 

The question is whether President Trump will swiftly undo these sanctions when he enters office. We don’t expect this to be the case, unless oil prices rise dramatically. The Biden administration has probably shied away from implementing this sooner because they were afraid of the effect on prices. But with OPEC sitting on plenty of spare capacity and the general view of an oversupplied market in 2025, now is the time. 

The problem is that this round of sanctions comes at the time when inventories are extremely low. Even with anemic demand in 2025, crude oil inventories declined from already low levels. US crude oil stocks are at dangerously low levels (See Exhibit 3)

Exhibit 3: US crude oil stocks are near 10-year lows

Thousand barrels

Source: EIA, Goldmoney Research

Crude oil stocks in the strategic hub of Cushing, Oklahoma, the point of delivery for the important WTI futures contract, are at 15-year lows, despite a massive capacity expansion over the last decade. 

Exhibit 4: Crude Oil stocks at Cushing Oklahoma are at 15 year lows

Thousand barrels

Source: EIA, Goldmoney Research

So far, the market has resisted panic as US inventories have lost a bit of their importance for US refiners given the record US production. In addition, strong refinery turnarounds in January should soon reverse the trend. But crude oil stocks are low on a global perspective (products stocks look a bit healthier but they are not high either).

The market has been complacent in our view because it expected the global deficit of 2024 to inevitably turn into a surplus in 2025, mainly on the back of non-OPEC production growth as a host of new projects come online. Thus, they weren’t extremely concerned about the low stocks and the positioning from speculators showed a very bearish outlook (see Exhibit 5). 

Exhibit 5: Crude oil speculative positions were at very low levels in 4Q2024

Brent Managed Money, Thousand barrels

Source: Commitment of Traders report, Goldmoney Research

The new Russia sanctions can now derail this view in the short term, as it is unlikely for OPEC to bring back barrels prematurely.

The problem with the current oil price rally – should it continue – is that it hit the global economy is in a very fragile condition. We think the oil market has been telling us that the global economy has slowed down rapidly over the past months as that crude demand growth slowed down dramatically last year. 

To understand the full picture, we need to take a step back. As a rule of thumb, demand for crude oil and NGLs (Natural gas liquids) tends to grow roughly at the speed of global economic growth (global GDP) minus 2% (annual efficiency gains). After the dramatic collapse in demand in 2020 on the back of COVID lockdowns, oil demand grew a lot faster than that for a few years. In 2021, 2022 and 2023, global oil demand growth was 5.8mb/d, 2.5mb/d and 2.1mb/d, respectively. Or in percentage terms, 6.4%, 2.6% and 2.1%. However, these were large base effects from COVID lockdowns. The demand for transportation fuels, which accounts for around 70% of global oil demand, was much harder impacted than economic activity overall as COVID policies targeted mostly the movement of people. Particularly Jet fuel demand was impacted for year. As the restrictions were lifted, oil demand in these sectors recovered and oil demand growth exceeded general economic growth for a while. These base effects had run out at some point in 2023, and thus we believe oil demand growth in 2024 was back in line with global economic activity.

However, in 2024, we witnessed a dramatic slowdown in global oil demand growth. Both the US Energy Information Administration (EIA) and the International Energy Agency (IEA) estimate that demand grew by only 0.9mb/d (0.9%) year-over-year. We believe these estimates are too high. Because supply – which is much easier to measure than demand – grew by only 0.4mb/d while global inventories declined by 0.2mbd, implied demand was closer to +0.6mb/d year-over-year. As there are no post-COVID base effects left, global oil demand of just 0.6% implies that global economic growth was around 2.6%. This is even lower than most estimates by the OECD and Wall Street which are around 3-3.2%. 

This anemic demand growth forced OPEC to maintain its production cuts which it put in place years ago, despite earlier plans to bring supply back gradually in 2024. OPEC was lucky that production in other parts of the world disappointed, as with this kind of demand growth, the world would have been awash in oil in 2024 even with the current OPEC cuts remaining in place.

Nevertheless, the first few months of 2024 saw a short-lived price spike on the back of production losses due to freeze offs in Texas, strong product margins on the back of Ukraine managing to bomb Russian refineries with drones and an escalation of Houthi conflict in the red sea. But ultimately weak demand prevailed and oil prices moved gradually lower. Hence, the oil market is telling us that the global economy is in a bad state, and there are no indications of a trend reversal.

Usually, when we see a slowdown in global growth, oil prices decline as well as demand weakens. Hence, lower oil prices have a cushioning effect on the economy when we go into a recession. However, there are historical examples where oil prices rallied for idiosyncratic reasons as the recession unfolded. This tends to have the effect of exacerbating the recession. The best example of this is 2008. The US had already entered a recession by the end of 2007, but oil prices continued to climb because of supply issues (mainly the lack of sweet crude as the refinery industry could not process more sour barrels). Sky high oil prices sent additional shockwaves through the global economy that was already caught up in the whirlwind of the subprime mortgage crisis. Oil went from $94/bbl in at the end of 2007 to $146/bbl by July 2008. Only as the decline in economic activity impacted oil demand enough, oil prices finally peaked and subsequently collapsed to $36/bbl by December, the biggest decline in history.

Exhibit 6: Oil prices continued to rally 6 months into the great financial crisis, ultimately exacerbating the economic slowdown

$/bbl

Source: FRED, Goldmoney Research

We think we are currently in a similar situation. In our view, the global economy is in a very fragile state. Europe is in an accelerating downtrend, and we see little reason for this to reverse anytime soon. The US had a great run, but higher interest rates, the aftermath of massive inflation, a weak housing market and many other factors seem to start taking their toll too. In our view, it’s unlikely that US growth accelerates in 2025. We admit, it could be that the first few months of the new Trump administration are once again accompanied by some economic euphoria, but President Trumps plans of significant tariffs on imports could spell doom in other parts of the world. The US dollar has already appreciated nearly 10%, which historically has harmed Emerging Market economies. But a stronger dollar is only one issue of the upcoming tariffs. Making it harder to export goods to the US is the other.

Which brings us to China. From an oil perspective, Chinas Economy is outright collapsing. In this century, Chinese oil demand has only declined once, in 2020, due to draconic COVID policies. Even in 2008-2009, Chinese oil demand growth remained strong, it even accelerated. But now, for the first time outside of COVID, Chinese oil demand declined in 2024. This can be seen as crude oil imports declined for the first time outside of a COVID year (See Exhibit 7) and refinery runs were also down year-over-year.

Exhibit 7: Chinese crude imports declined in 2024, the first time outside of a CVOID year

Million b/d

Source: China Customs Data, Goldmoney Research

Exhibit 8: Chinese refinery runs also declined in 2024, indicating a lack of demand of petroleum products

Thousand b/d

Source: China Statistics Office, Goldmoney Research

The Chinese leadership still aims at 5% GDP growth in 2025. That is down meaningfully from the 8-10% in the past, but it’s not a disaster on its own. And we think they will manage to achieve it, as they always have. The problem is how this growth can realistically be achieved. In the past, growth targets were largely met by stimulating the infrastructure and housing sectors. But those days are clearly over. The housing sector is in shambles and it’s a massive drag on Chinese households who hold 70% of their wealth in property. We also don’t expect the same infrastructure investment programs as in the past, largely because those were typically financed by local governments. But local governments have a massive debt problem, and the central government will not allow them to go even further into debt. 

The Chinese leadership clearly hopes to stimulate domestic consumption, a long-term goal. But we are skeptical whether the Chinese consumer can be persuaded to spend, when their wealth continues to crumble in front of their eyes and the economic future remains bleak. Hence, the most likely way to achieve the GPD goals, is a continuation of 2024, when China was saved by exports. 

However, while this may help China to achieve its goals, globally it’s a zero-sum game. Every dollar exported by China is a dollar imported from China somewhere else and displaces consumption of domestic production in the importing nations. And because President elect Trump is about to unleash tariffs on Chinese imports, more Chinese exports will have to go elsewhere, mostly Europe. But we believe Europe is not too keen on taking more Chinese imports either as its industry is already in decline.

For now, global economic growth has simply slowed down, it hasn’t outright collapsed. There are still pockets of strength, India for example. But if this oil rally continues, it will start adding pressure on western economies, and even China as it imports most of its oil. Add the rally in global gas prices and this becomes concerning for the global economy in 2025.