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Analysis | The Oil Market Needn’t Fear a Calamitous US Recession

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Rising US interest rates, sky-high oil prices, soaring inflation, a foreign war. Then, naturally, a recession.

The trajectory may sound awfully familiar, but I’m not describing the present-day American economy. Instead, this is what the US looked like in early 1990. The commodity market now fears a repetition — with another cycle of rising interest rates, expensive oil and a disruptive military conflict leading to an economic slowdown.

Macro hedge funds are already betting that oil demand will crash and prices will drop. Yet the bears may be catastrophizing the true impact of a recession. A review of how oil demand responded to a cooling American economy three decades ago can explain why an economic slowdown today might not be too terrible, and how oil prices can stay higher than many expect.  

Back then, the Federal Reserve spent several months tightening its monetary policy, raising interest rates from 6.5% in early 1988 to almost 10% in late 1989. Economic activity was slowing already, with the business cycle largely exhausted, by the time Saddam Hussein invaded Kuwait in August 1990, sending oil prices to what was then a record high of $41.15 a barrel. The US economy promptly fell into recession. Although oil demand slowed, it still kept growing, posting an annual year-on-year expansion in both 1990 and 1991. 

In 2022, the US and European economies appear to be heading in the same direction. Consumer and business sentiment has weakened markedly. Over the weekend, Lloyd Blankfein, the former head of Goldman Sachs Inc., warned consumers and businesses to brace for the “very, very high risk” of a recession in the next few months.

For the oil market, the key question isn’t if — or even when — American and European economic activity will slow and probably contract. Most oil investors assume it’s a matter of time: It’ll happen either after the summer, or perhaps in early 2023. The key question is, then, what kind of slowdown we’ll see. Will this be a mild recession, à la 1990-1991 and 2001? Or will it resemble an epic cataclysm more like the crises of 2008-2009 and 2020? Something in between?

Investors tend to see events through the lens of what they have experienced most recently. Unsurprisingly, the word recession today conjures memories of the brutal global financial crisis and the Covid-19 pandemic. In both occasions, oil demand contracted, something the market hadn’t experienced since the early 1980s. In 2020, global oil demand plunged by nearly 10 million barrels a day — the biggest ever drop recorded. In 2008, it dropped by 1 million barrels a day, followed by another contraction of 1.1 million barrels a day in 2009. Back then, the world hadn’t seen two consecutive years of negative oil demand in a quarter of a century. 

But older oil traders will remember that the milder US recessions of 1990-1991 and 2001 were very different. Global oil demand growth weakened, but it never contracted. After experiencing annual growth of about 1.3 million barrels a day during the previous five years, oil demand grew just 670,000 barrels a day in 1990, then slowed further to 134,000 barrels a day in 1991. The average growth was similar before 2000, when oil consumption weakened to 724,000 barrels a day, followed by growth of 870,000 barrels a day in 2001. 

Unless the war in Ukraine spills over to the rest of Europe, the next recession looks more likely to resemble that of 1990-1991 than of 2007-2008. If that’s the case, oil demand may be weakened from the downturn, but it should still see annual growth. Oil prices would drop, but they likely won’t collapse. 

The outlook for 2022-2023, of course, is complicated by multiple factors. Oil demand is still recovering from the impact of the pandemic, and some sectors of the American and European economies are only now emerging (aviation is a notable example), with Asia still further behind. High energy prices and slower economic activity could curb pent-up demand. Or the reopening of China post-Covid could boost global economic activity.

If the next recession-slowdown resembles that of 1990-1991 or 2001, oil demand growth may prove stickier than many believe. If so, Saudi Arabia and the rest of the OPEC cartel would be in a relatively comfortable position to manage things. With Saudi production set to hit an annual all-time high in 2022, the kingdom can easily cut output in 2023 if needed. If Russian oil production continues to decline, OPEC may not need even to act to support the market. 

The Fed, the European Central Bank and the Bank of England face, however, a more difficult challenge. Without a significant slowdown in oil demand, including an outright contraction, energy prices are likely to remain high, stoking inflation. 

Ultimately, what the next economic slowdown looks like rests on the shoulders of Western central banks. Betting that oil prices will crash is betting that Chairman Jerome Powell will trash the global economy. It may happen, but there’s a greater chance that a softish landing, with a mild recession, will be as bad as it gets. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Javier Blas is a Bloomberg Opinion columnist covering energy and commodities. A former reporter for Bloomberg News and commodities editor at the Financial Times, he is coauthor of “The World for Sale: Money, Power and the Traders Who Barter the Earth’s Resources.”

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