Crude oil prices have experienced a wild ride during the past twelve months. West Texas Intermediate (WTI) crude oil hit a high near $130 immediately following the attack on Ukraine and slipped to a low near $70 near the end of 2022 (see chart). The Chinese outlook has also played a role, with lockdowns and reopenings followed by better-than-anticipated growth data. Crude oil prices are generally driven by supply and demand. OPEC and Russia have experienced their fair share of issues in the past twelve months, from output cuts to the lack of nations willing to accept Russian crude oil. In the wake of the pandemic, U.S. crude oil output slipped, but production has been storming back and will likely test all-time highs in 2023.
The COVID-19 outbreak in the United States generated one of the most volatile periods for crude oil in history and displayed the volatility associated with crude oil investing. Economic data in the United States started to show that the U.S. economy was plunging into recession as lockdowns were creating massive layoffs. In April, the U.S. economy saw the unemployment rate jump from 10.3% to 14.7%, one of the most significant increases in history. The number of unemployed people rose by 15.9 million to 23.1 million, which also spooked market participants. Traders quickly realized that growth prospects were tumbling and the number of people likely to be driving cars and trucks was dropping.
In April 2020, the response to the perceived lack of demand for WTI crude oil created a spectacular event where prices dropped below zero. U.S. oil producers did not respond as quickly as refiners to the lack of demand for crude oil, which led to a glut of crude oil. According to the Energy Information Administration, refiners (who blend crude oil into consumer products such as gasoline and diesel fuel) between March 13 and May 8, 2020, decreased crude oil inputs by 20%.
The glut of crude oil made storage expensive as there was no place to put any crude oil in Cushing, Oklahoma, where WTI crude oil is priced. Storage became so expensive while the oil demand continued to slip that the price of WTI declined below zero. The decline of prices below zero was the first time that oil cost was in negative territory. The catalyst was the pandemic and the lockdowns that pushed demand to levels well below supply. Not only were people expected to drive less, but no one was taking air transportation. Supply chains were shuttered as trucking was halted, cutting off demand for diesel fuel.
Central Banks Cut Rates to Zero Buoying Demand
The end of the lockdowns helped crude oil rebound, and prices rebounded back to the $70 level ahead of 2022, fueled by central bank activity. Central banks around the globe dropped interest rates to zero or below to fuel demand, hampered by lockdowns and the continued spread of the COVID-19 virus. Central banks also embarked on quantitative easing programs pumping liquidity into the marketplace to fuel demand and buoy growth. As lockdowns started to subside in the United States and Western Europe, driving and air travel began to accelerate.
TSA travel numbers in the United States dropped from 2.5 million passengers per day in 2019 before the pandemic to a low near 500 thousand in the summer of 2020. As the lockdowns subsided, travel numbers started to pick up, rebounding back to pre-pandemic levels by the summer of 2022. The increased air travel led to a pick-up in oil use, pushing prices back to pre-pandemic levels (see charts).
In February 2022, Russia invaded Ukraine again. In 2014, Russia annexed Crimea, part of Ukraine, and in 2022 Russia started seizing the Donbas region in Ukraine. The invasion began on February 24, when Russian President Vladimir Putin announced a special military operation seeking to demilitarize Ukraine. Nations condemned the attack. To further punish Russia, the United States, European Union, Canada, Japan, the United Kingdom, and Australia said they would not use Russian oil.
In 2021 before the attack, Russia was the second-largest oil producer globally. Russia produced 13.1% of the oil and oil products, such as gasoline and diesel fuel. Most Russian oils were purchased by Europe, which created a panic. Oil traders were concerned that there would not be enough oil globally. The war would make it impossible for Russia to continue to pump enough oil, and there would be a tremendous demand for non-Russian oil as countries that are net importers turn their backs on Russia.
In the aftermath of the attacks, oil prices spiked and, in March 2022, moved up to $130, hitting highs not seen since 2007/2008. Despite Russia’s overtures before the attacks, the world was unprepared for the lack of Russian production. The United States, the world’s largest oil producer before the attacks, was still not producing as much oil as it had before the pandemic. The lack of supply was another critical event.
Central Banks Start Tightening Monetary Policy
Oil prices remained elevated as low-interest rates fueled demand and economic growth flourished. As lockdowns started to wane in 2022, air travel began to accelerate, increasing demand. Supply started to grow, but prices remained too high, generating a tax on consumers.
To fend off rising inflation, the U.S. Federal Reserve increased interest rates to bring down prices. The Fed targeted all prices, including food, energy, housing, and wages. In 2022, the Federal Reserve increased interest rates by 4.25% to crush demand and bring down inflation. The Fed and another central bank tightening the monetary policy, started to weigh on energy prices pushing crude oil prices back down to the pre-Russian attack levels.
The Strategic Petroleum Reserve
To further drive down the price of oil to make gasoline and diesel less expensive, the United States started to release a portion of the oil it held in its strategic petroleum reserve. The reserve is used during times of crisis to provide oil to U.S. consumers and reduce prices during price spikes. The large volumes of crude oil released by the United States also weighed on crude oil prices just as the Fed was accelerating interest rates to reduce demand.
Chinese Growth Buoys Prices
As the lockdowns in China are lifted, there is a chance that demand is buoyed. If China can avoid waves of the spread of the COVID-19 virus, then travel for business and leisure will likely buoy demand for oil and products. In January, China reported that Gross Domestic Product (GDP) increased by 3% yearly, which was more than anticipated. In Q4 Chinese GDP grew by 2.9%, which was more than the 1.8% expected. What is also clear is that Chinese buyers are looking for leisure activities and less for goods. China reported that retail sales for goods declined by 0.2% for 2022.
The increase in growth comes despite a lockdown that was not lifted until December 2022. Shanghai locked down for about two months in Q4 to control the COVID-19 breakout. The uprising in Shanghai toward the zero-COVID policy led the government to reverse its stance and move toward a living with Covid scenario. China is reporting an increase in active cases with mild conditions as the country continues to open. If China can avoid serious or critical situations due to COVID, the travel demand will continue to buoy the price of oil.
The Bottom Line
The upshot is that oil has experienced a wild ride over the last twelve months due to several current events. The volatility started with the pandemic as prices tumbled below zero, the first time on record that prices moved into negative territory.
Prices then trended upward as central banks around the globe started to reduce interest rates to spur economic growth. The move by the central banks came as producers were halting production due to the lack of demand. The rebound in growth came as oil producers were unprepared to provide enough oil.
The rally peaked following Russia’s attack on Ukraine. Prices spiked as Russia, the second largest oil producer, supplied most of Europe. Countries around the globe decided not to accept Russian oil, which made oil produced by other nations more attractive. The rally in oil prices ended as central banks worldwide started to increase rates. The change in monetary policy came as the Biden Administration released half of the U.S. strategic petroleum reserve. Now that China is opening after years of lockdowns, oil demand is starting to rebound, which could again buoy prices.