Demand destruction ‘weighing on oil prices a lot right now,’ analyst says

Global X ETFs Director of Research Rohan Reddy joins Yahoo Finance Live to discuss oil prices, inflationary concerns, demand destruction, and the state of the economy.

Video transcript

- Oil prices are under pressure again today staying under the key. $100 a barrel mark as recession fears persist. Joining us now to discuss is global ETFs Director of Research, Rohan Reddy. Rohan, good to see you here. So what do you think is actually driving this decline? Is it just straight recession concerns?

ROHAN REDDY: We think a lot of it has been coming up right away. The inflationary concerns have obviously been persisting in the economy for the vast majority of the last few months and ever since the COVID 19 pandemic, but we're getting to the point where demand destruction is now starting to factor into a lot of the economic concerns being weighed into oil prices.

And even though there is this supply side ballast of OPEC not aggressively raising production, more of the concerns right now are very strong dollar, hawkish Fed. And so we've gotten to the point where in the past few months, a lot of the economy was able to resist those pressures but now, they're definitely weighing on economic growth and the trajectory of that. So we do think that that's actually weighing on oil prices a lot right now.

- OK, so it was believed that at about $125 a barrel, WTI crude. That's when we would start to see some of the demand destruction. We've crossed that threshold, we've retracted from it, retested it a couple of times. And so at this point as we're now sitting just in the ballpark of $100 and cross below that yesterday for the first time since May, what does that signal for the back half of this year? And if that demand destruction is still at play here.

ROHAN REDDY: Well, spot oil prices were already very high to begin with and some of that was just because we were coming out of a public health crisis and supply was definitely not enough to keep up with demand. Some of the cooling off that we've seen in prices that you mentioned, Brad, has been short-term. But I think the trajectory over the long-term, especially in the next six to 12 months looks relatively positive because the dollar is very strong right now, it's unlikely to persist for that much longer.

The economy is in generally good shape. We have seen emerging market economies are starting to climb out of that challenging period over the last couple of years. And China specifically with the lockdowns, it looks like they're going to get lifted relatively soon, and that economy is second largest in the world. Should add some demand to oil prices. So we're actually relatively positive on the price of oil over the next six to 12 months. But we do believe that there's going to be a lot more volatility in oil prices.

So for investors, we actually think you should take a more defensive approach, maybe through assets such as pipelines as opposed to E&P companies.

- But if one is inclined, Rohan, to think that a recession is here or is looming, and that could push oil prices down below 70 bucks like Citigroup implied earlier this week. What is the trade there? How do they go short oil?

ROHAN REDDY: Well, the likelihood of $70 oil seems pretty low to begin with just because there is not enough supply to really drive the price that low, and OPEC has not really been super inclined to raise production aggressively from here. US shale producers could make up some of that shortfall but less so on OPEC. However, if prices were to dip that low, we do think one area aside from outright hedging of oil prices is to look a little bit more defensively.

So we spoke about pipeline stocks, those benefit from a US oil and gas production. So if US shale producers were to raise production a little bit more aggressively from here and prices were to start to fall, that's a nice area to sit in to collect cash flows during this more volatile period. So aside from directly betting on the price of oil, we do think getting a little bit more defensive in the energy complex might be a more appropriate way to go about it.

- So what do you believe is to happen after the OPEC plus COVID-19 policies expire in a couple of months?

ROHAN REDDY: It's a very good question because we've seen, there's been a lot of runway for OPEC to say, we're going to aggressively raise production. But obviously, that has not happened a lot in their discussions over the last few months and even the past year or so, even though they've been given a couple of openings. So some of it is just because I think the Chinese economy has been a little bit seesaw-ish, and so they haven't been as big of a driver in the economic growth equation.

But some of this is also the fact that we are facing high inflationary pressures, the runway after a decade long, plus cycle is maybe starting to come to a close or you could see some tea leaves, where it's starting to come to a close. So I actually think there's less likelihood that OPEC is going to significantly raise production from here. We do think modest growth is likely.

But after this deal expires and the quota agreement from OPEC plus expires, we think there isn't going to be this massive unleashing of oil. There's rather going to be a more gradual and steady approach to it.

- Rohan, you mentioned China, and that economy is starting to open back up after the COVID-related restrictions. If we were to get a string of positive reads on the Chinese economy over the next few months, what would that do to oil prices?

ROHAN REDDY: That would frankly be massive just because it is the second largest economy in the world. And we have seen even if you look at the Chinese equity markets as a proxy, ever since the lockdowns hit a couple of months ago, equity prices in the Chinese markets were falling off a cliff, but they had this massive snapback rally when it looked like lockdowns were starting to get lifted.

So we do think that could actually be a really big demand side pull forward if the Chinese economy starts reading through on some of the economic prints pretty well and you start to see factory and PMI data improve a lot. That's going to add a little bit more legs to this economy and some more fire into oil prices. So again, the likelihood of that happening after a prolonged period where the economy was not entirely fully functioning is maybe a little bit lower than some market participants would hope for.

But we do think right now the pricing and power of what market does expect for the Chinese economy is relatively low, so there is more upside from the Chinese economy on some of these economic prints that is being priced in.

- Rohan Reddy, who is the Global X ETFs director of research. Rohan, appreciate the time here on the day. We'll have to have you back and continue the conversation. It's not going away anytime soon, we know.