oil prices fall. The worst case could be $40 a barrel.

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Oil prices fell again on Friday, hitting their lowest level since December 2021. Analysts are becoming increasingly aware that the slowing economic forces are outweighing the bullish effects of China’s recovery and sanctions on Russia.

West Texas Intermediate crude oil futures, the US benchmark, fell as low as $65.17 a barrel on Friday, down 4.7% from Thursday’s settlement levels. Brent crude, the international benchmark, fell as much as 4.4% to $71.40 a barrel. Both products recovered somewhat around midday but were still trading in the red on the day. Brent is down about 15% in the last 10 days alone. The

Energy Select Sector SPDR ETF
(Ticker: XLE) declined 1.5%

Part of the decline appears to be a paper loss unrelated to actual oil supply and demand.

“As the end of ‘cheap money’ rocks the financial sector, one can only assume that the same higher funding costs for speculative commodity positions contributed to a nearly 13% collapse in short-term oil options,” he wrote

Bank of America

Analyst Doug Leggate.

But it’s also fueled by statistics showing that people and businesses aren’t using that much oil how it is produced, resulting in more oil having to be sent to storage tanks. Globally, 120 million barrels of oil have accumulated in storage over the past three quarters as supply exceeded demand. Even with China reopening, analysts don’t expect the balance to shift for months.

“The oil market will remain in surplus over the next two months, with oil prices under fundamental pressure through May as global inventories are likely to expand by another 46 million barrels,” wrote Natasha Kaneva, head of global commodity research

JP Morgan
.

Kaneva had expected Brent to average $89 in the second quarter, but now thinks prices are less likely to bounce back to those levels in the short-term. Instead, she sees prices ranging from $70 to $80 unless one of two things happens.

The first catalyst would be a shift in strategy from OPEC, which has been sticking to a production schedule it first laid out in October in collaboration with a larger group called OPEC+, which includes Russia. At the time, OPEC’s strategy of cutting production by 2 million barrels a day drew criticism from the US because officials said it would push up prices. US officials feared that higher prices would lead to a pain at the pump and higher oil revenues for Russia.

Now it looks like OPEC has been too modest in its cuts, at least from the oil bulls’ perspective. Economic conditions have deteriorated so much that OPEC’s current production schedule may be contributing to overproduction and causing prices to fall. There’s a chance the group might decide to make more cuts next week, though OPEC officials recently scrapped the idea. Kaneva believes the group could cut quotas by about 400,000 barrels per day, a small but significant chunk of the 100 million barrel daily oil market.

The other catalyst would be an announcement by the US government that it would begin replenishing Strategic Petroleum Reserves (SPR), which are at their lowest levels in decades. Large oil purchases by the government would likely lead to rising prices. President Joe Biden said last year that the administration would consider buying if oil was at or below $67-$72 a barrel, levels that would apply today.

But the Department of Energy is currently still selling oil from the SPR due to congressional mandated sales. Ministry officials have said they cannot buy and sell oil from the SPR at the same time due to logistical reasons. But Biden said the department could buy oil for the SPR to be delivered on fixed-price contracts in the future – which would allow the government to buy now on the condition that the oil be delivered in a few months. The department did not immediately respond to questions about whether it will do so.

Without these two catalysts, oil price developments could depend on the shape of the banking turmoil. If things get worse, Kaneva warns that prices would fall precipitously because recessions caused by a financial crisis are typically two to three times worse for oil than other recessions.

“Historical analysis shows that financial market contagion has tended to seep deeper and longer into the physical economy, cutting consumer spending and crushing oil demand,” she wrote. If current troubles infect the entire regional banking system, Brent could fall as low as $40.

Write to Avi Salzman at avi.salzman@barrons.com