Oil Prices Signal Potential Demand Slowdown, Echoing Recessionary Fears
Recent steep declines in oil prices have sparked concerns about a potential demand slowdown that could mirror a mild recession, according to a new analysis by Morgan Stanley. While the investment bank’s economists anticipate a "soft landing" for the U.S. economy, the troubling signals in the oil market suggest a recession-like scenario "is not entirely to be dismissed," said Martijn Rats, commodity strategist at Morgan Stanley.
Key Takeaways From Morgan Stanley’s Analysis
- Oil prices have plummeted in September, with Brent and U.S. crude oil posting their worst weeks since October 2023. This steep decline has raised concerns about demand weakening, potentially mimicking the conditions seen during recessions.
- Morgan Stanley’s analysis indicates a surplus of about 1 million barrels per day in 2025, pointing to a potential inventory build that aligns with historical patterns seen during U.S. recessions.
- The comparison of current oil prices to historical patterns suggests a demand slowdown similar to a mild recession, but not as severe as the 20 million barrel per day collapse witnessed in early 2020 or the 3 million barrel per day contraction in mid-2008.
- Increased OPEC production and robust output in other regions could also contribute to the build in crude oil inventories, potentially overshadowing the impact of decreasing demand on prices.
- Although the market may be signaling a demand slowdown reminiscent of a recession, Morgan Stanley remains cautious, emphasizing that demand indicators are concerning but not conclusive.
The Price Dip and Historical Parallels
The sharp decline in crude oil futures, with Brent and U.S. crude both down more than 15% for the quarter, has prompted comparisons to historical periods characterized by economic downturns. Morgan Stanley’s analysis highlighted two specific periods – the start of the Covid-19 pandemic (Dec. 2019 to March 2020) and the financial crisis (June to September 2009) – as potential parallels to the current market situation.
"Naturally, that paints a weak picture," Rats said, referring to the price trajectory mirroring these previous periods. However, it’s important to note that while the price movements might resemble those of past economic downturns, the current demand outlook is nowhere near as dire as the 20 million barrel per day collapse of early 2020 or the 3 million barrel per day contraction in mid-2008.
Demand vs. Supply: A Complicated Equation
The decrease in oil prices could be attributed to a combination of factors, including a potential demand slowdown driven by a mild recession and an increase in supply from OPEC and other producers.
Morgan Stanley notes that the difference between the first-month and twelfth-month Brent contract suggests an increase in crude oil inventories in developed economies by 150 million barrels. This number falls within the range of inventory build observed during the past five U.S. recessions, ranging from 150 million to 220 million barrels.
"This implies a demand slowdown similar to a mild recession," Rats wrote in his note to clients.
However, OPEC+ is planning to increase production starting in December, and output in the U.S., Canada, Brazil, and Guyana is also strong. This increase in supply could also be contributing to the inventory build, masking the impact of any potential demand slowdown.
A Cautious Outlook
While the oil market signals a potential demand slowdown reminiscent of a recession, Morgan Stanley cautions against drawing definitive conclusions. The investment bank acknowledges the concern surrounding demand indicators but emphasizes that it is too early to assume "recession-like" demand as the base case.
"It’s best to keep an open mind," Rats wrote. "Demand indicators are concerning but it remains too early to make ‘recession-like’ demand the base case," he said.
The bank is actively monitoring the situation, particularly with concerns around global economic growth, and will continue to refine its outlook based on further developments in the oil market.
This recent price drop, coupled with the historical parallels, highlights the uncertainty surrounding future oil prices. It’s a complex scenario where demand and supply are intertwined, with a potential recession lurking in the background. Whether the current oil price movements are a sign of a coming recession or simply a reflection of supply dynamics remains to be seen.
