By Alex Kimani
- Currently, the U.S. economy is finely balanced between a significant mid-cycle soft patch and a full-blown recession.
- Financial and economic experts often disagree at the time whether the economy is already in recession.
- Despite the mixed signals being sent by various sectors, the energy markets remain surprisingly resilient with oil inventories declining.
After testing multiyear lows over the past few weeks driven by fears of a recession and risk aversion prompted by turmoil in U.S. banking, oil prices are climbing again in Monday’s session as oversold markets bounce back. Recessions are known to kill demand for oil and gas faster than anything else, bar major black swan events like the recent global pandemic and subsequent lockdowns. Major recessions not only cause widespread job losses, leading to fewer people commuting to work but also generally lower consumer spending. This leads to a reduction in the amount of fuel consumed.
“When the world goes into recession and the demand for commodities goes down, the [oil futures] market is unforgiving,” oil analyst Andy Lipow has told CNN.
So, the million dollar question at this point is whether or not the U.S. economy is already in a recession. It’s not an easy question to answer because recessions have historically proved notoriously difficult to pin down with precision. Financial and economic experts often disagree at the time whether the economy is already in recession, and sometimes struggle to determine whether we are truly in a recession or merely in a “soft patch” in an otherwise business cycle expansion.
Although most countries informally define a recession as two consecutive quarters of negative growth in real gross domestic product, the United States’ National Bureau of Economic Research (NBER) defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.”
This definition emphasizes depth, diffusion and duration so as to distinguish between true recessions and milder slowdowns in the whole economy or cyclical downturns confined to one or a few sectors. NBER looks at economy-wide measures of economic activity including nonfarm payroll employment, personal income less transfer (PILT) payments, real personal consumption expenditures, household employment and industrial production, among others.
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Typically, the NBER determines whether a recession has occurred months after it started, with some downturns coming close to being a recession but not quite making the cut. According to the NBER chronology, the most recent peak occurred in February 2020 while the most recent trough occurred in April 2020.
Currently, the U.S. economy is finely balanced between a significant mid-cycle soft patch and a full-blown recession.
Source: National Bureau of Economic Research
U.S. market sectors are currently sending mixed signals, with some already contracting while others have managed to remain afloat.
The industrial sector, including the manufacturing and freight transportation, is currently going through a prolonged downturn that fits the criteria for a recession. Monthly business surveys have repeatedly shown that manufacturing activity has been on decline since November 2022, with the downturn confirmed by declining levels of container freight, diesel consumption and industrial electricity sales.
Luckily, the much larger service sector has been recording marginal growth, small but enough to keep the economy as a whole out of recession.
The manufacturing sector index clocked in at 47.1 in April compared with a 51.9% reading by the Institute for Supply Management’s (ISM) service sector index. A reading above 50 indicates growth and one below it shows contraction. The services index generally tends to be higher than its manufacturing peer throughout the economic cycle, although both markers move in broadly the same direction. Both indices are low even by historical standards with the manufacturing index in only the 9th percentile while the ISM services index is in the 15th percentile for all months since 1997.
The consumer sector has been largely positive, with growth in consumer spending helping offset a sharp deceleration in business investment. Most households have been able to keep spending at relatively high levels thanks to income gains from rising employment, tax cuts and cost-of-living adjustments to wages and salaries.
Real PILT payments increased by 1.7% Y/Y in the first quarter of 2023, a significant increase from 0.3% in Q2 2022. Lower energy prices have relieved pressure on household budgets while employment in both the manufacturing and the services sectors has been increasing though the rate of growth is slowing.
Another negative: credit conditions have been tightening for both households and businesses following a sharp increase in interest rates and the regional banking crisis.
What It Means For Energy Markets
Despite the mixed signals being sent by various sectors, the energy markets remain surprisingly resilient with oil inventories declining and demand in the pivotal Chinese market growing as domestic travel rebounds. WTI crude was up 2.1% to $72.85 per barrel on Monday at 1100 hrs ET while Brent gained 1.8% to trade at $76.63. Natural gas (Henry Hub) prices were up 2.3% to $2.19 per MMBtu.
According to the International Energy Agency, global oil consumption remains on track to rise by 2M bbl/day this year to an all-time high 101.9M bbl/day. Inventories are gradually tightening, and should deplete further as OPEC+ implements new production cuts.Crude oil inventories have fallen below the five-year average for the first time this year. Last week, implied gasoline demand rose by 992 thousand barrels per day (kb/d) w/w to a 15-month high of 9.511mb/d.
StanChart has predicted that the OPEC+ cuts will eventually eliminate the surplus that had built up in the global oil markets over the past couple of months. According to the analysts, a large oil surplus started building in late 2022 and spilled over into the first quarter of the current year. The analysts estimate that current oil inventories are 200 million barrels higher than at the start of 2022 and a good 268 million barrels higher than the June 2022 minimum.
However, they are now optimistic that the build over the past two quarters will be gone by November if cuts are maintained all year. In a slightly less bullish scenario, the same will be achieved by the end of the year if the current cuts are reversed around October. This should o shore up prices.
Meanwhile, natural gas prices are expected to increase in the latter half of the year as Europe goes on yet another buying spree. Europe has failed to secure enough long-term LNG contracts to offset cut-off Russian gas imports, with Reuters predicting this may prove costly next winter and could sharply tighten the market. The European Union views natural gas as a bridge fuel in the transition to renewable energy, and buyers generally struggle to commit to long-term contracts. This means that Europe might be forced to buy more from the spot markets like it did in 2022, which in turn is likely to push prices up:
“Since the green lobby in Europe has managed to persuade politicians wrongly that hydrogen to a large extent can replace natural gas as an energy carrier by 2030, Europe has become far too reliant on spot and short term purchases of LNG,” consultant Morten Frisch has told Reuters.
By Alex Kimani for Oilprice.com