The Fed might not see a recession coming but the oil market is pricing one in, says Phil Flynn of PRICE Futures Group.

Oil collapsed into “bear market territory” in a technical price crash even as global demand notched a record high for the third month in a row.  Oil is on track for its fourth weekly loss in a row driven by a near-record hedge fund short position and a preponderance of economic pessimism that is not being backed up in other economic data. The oil market seems to be sensing that we will soon face rising unemployment coupled with weakening economic output and rapid disinflation which could happen but has not happened yet.

Some point to better-than-expected oil output from places like Iran and Russia as the world has failed to hold those countries accountable for their crimes. While the Biden administration says that they will indeed enforce sanctions on Iran and hold shippers of Russian crude responsible for violating the laughable Russian oil price cap, the reality is that the market doubts they will succeed in those actions. Not because they can do it but because they feel the political fall-out of rising gasoline prices more than they fear another Iranian-funded terror attack or making Russia pay an economic price for invading Ukraine.

JODI also reported a slight increase in Saudi oil production from 57,000 barrels per day (mb/d) to 8.98 mb/d. Jodi also reported that China’s crude imports fell by 1.31 mb/d month over month to 11.16 mb/d raising some concerns about demand.

We are also getting strong US oil production because of the efforts of the US energy industry which has raised its portion despite being slandered and forced to go to court against an administration that has said quite clearly that they want to put them out of business.

Yet could this hedge fund-driven price crash force US oil producers to pull back from future production plans? The answer is yes, the odds that we have seen a peak in US output were close, but this price crash will cause a peak and a drop in US oil production in the coming months. That makes a note from the Energy Information Administration even more timely.

Yesterday the EIA released a Short-Term Energy Outlook Perspective that explored how different crude oil prices affect US crude oil and natural gas production. The EIA wrote that “Crude oil prices significantly affect US crude oil production: higher prices, especially when sustained, provide an incentive for producers to drill and produce more crude oil. Similarly, producers reduce drilling activity and production during periods of low crude oil prices. These changes in crude oil production also affect natural gas production because some natural gas is produced from oil wells. The EIA says, “If we assume, based on past WTI closing prices, a 45% higher price environment of $125/b, we forecast a 4% increase in crude oil production from the Lower 48 states by the end of 2024 over the base case. In a 24% lower price case with WTI at $65/b, we forecast 4% less production in the Lower 48 states relative to the base case.”

I would take it a step further. When we see the type of step break that we saw in oil that we have seen in the last month the oil companies freeze. They will wait to see the price stabilize before approving any projects. I guess that the break that we have seen will reduce production as they put off projects.

Technically oil prices and product prices are in trouble but they are way out of whack with supply and demand fundamentals we expect a sharp recovery in prices at some point and continue to recommend putting hedges on these weak prices we don’t believe that the tight supply situation is going away we also believe that OPEC is not going to stand either way by and allow prices to continue to fall while we have a lot of work to do to turn things around we are extremely oversold.

If we don’t get a recession the possibility of return to $90 or $100 a barrel oil is still on the table. Natural gas got hit with a bearish EIA report. John Kemp at Reuters wrote that “US gas investors showed an increasing surplus after a brief cold snap tightened them earlier in November. Inventories were +96 billion cubic feet (+3% or +0.43 standard deviations) above the prior ten-year seasonal average on November tenth up from +52 billion cubic feet (+1% or +0.23 standard deviations) a week earlier. Inventories tightened briefly in response to a burst of unseasonably cold weather across the major population centers between October 29 and November third but have since swelled again.

Learn more about Phil Flynn by visiting Price Futures Group.