Oil Prices Fall Below $85 a Barrel Has the supply situation been fixed?

Oil Prices Fall Below $85 a Barrel Has the supply situation been fixed?

September 12, 2022

I wish I could say “yes,” that the supply situation has been fixed, but this recent decline is all about expected demand. According to a recent article in the Wall Street Journal:

“Expectations for demand to decline amid deteriorating economic conditions have pulled them lower. Lately, demand concerns have been winning the tug of war. The oil market is going from recession fears to recession acceptance, said Stephen Richardson, an Evercore ISI Analyst.”1

The article goes on to say that consumption is declining in the U.S. and Europe, where high prices have limited demand, and central banks are raising interest rates to fight inflation, potentially at the expense of slowing economic growth.  

Another concern weighing on oil prices is the recent shutdowns in China over a new outbreak of COVID-19. One of China’s biggest cities, Chengdu, recently announced a lockdown of its 21.2 million residents as it launched four days of citywide COVID-19 testing, as some of the country’s most populous and economically important urban centers battle outbreaks. Chinese factory activity contracted for the first time in three months in August amid weakening demand, while power shortages and new COVID-19 flare-ups disrupted production. These new lockdowns affecting millions have been put in place, even though Mainland China has reported no COVID deaths since May, leaving the death toll at 5,226.2

WTI Strip Prices Decrease

Spot prices and futures prices for the WTI contract decreased by approximately $5.00 per barrel in the near term and by approximately $5.00 per barrel over the longer term.

WTI Strip Prices - One Month Change

one month change of WTI strip prices

As shown, the oil price curve remains in a state of “backwardation,” reflecting the market’s expectation of lower future spot prices.

Oil Price Outlook

The price distribution below shows the crude oil spot price on September 7, 2022, as well as the predicted crude oil prices based on options and futures markets. Blue lines are within one standard deviation (σ) of the mean, and red lines are within two standard deviations.

crude oil standard deviations

Based on these current prices, the markets indicate there is a 68% chance oil prices will range from $64.00 and $112.00 per barrel in mid-December 2022. Likewise, there is roughly a 95% chance that prices will be between $41.00 and $158.00. By mid-February 2023, the one-standard deviation (1σ) price range is $59.50 to $120.00 per barrel, and the two-standard deviation (2σ) range is $34.00 to $185.00 per barrel.

Key Takeaways

Remember that option prices and models reflect expected probabilities, not certain outcomes, but that does not make them any less useful. The heightened volatility caused by recent events has led to extraordinary futures price ranges. While the mid-February 2023 settlement price is $81.24, the 1σ range has a spread of $60.50, and the 2σ range has spread of over $151 per barrel. These factors add up to a challenging price environment for capital allocation decisions.

  1. Oil Posts Third Straight Month of Declines, The Wall Street Journal

  2. Chengdu locks down 21.2 million people as Chinese cities battle Covid-19, CNBC