Much of Western Europe wilted last week as the first heat wave of the year made an early appearance. The same can be said for the oil market. Friday’s price meltdown capped a tumultuous week for oil prices in which tightening monetary policy across the world sparked a flight from riskier assets. Leading the fight to tackle soaring inflation is the Federal Reserve. The US central bank announced a whopping 75 bp rate hike, the biggest increase in almost three decades, and warned of a similarly hefty rate rise and next month’s meeting. Not wanting to be left behind, other major central banks jumped on the bandwagon of monetary tightening including the Swiss National Bank and the Bank of England.

The backdrop of aggressive monetary tightening policies, a firmer US dollar and Russian hints of rising oil production and exports made for a potent bearish cocktail. Brent and WTI suffered their first weekly decline in over a month with respective drops of 7% and 9%. Stock markets were also shaken as rate hikes set the stage for weakening growth. Leading US equity gauges suffered their heaviest weekly fall since the outbreak of the coronavirus pandemic.

A slowdown in global economic growth now looks inevitable. Sure enough, a flurry of various international organizations and banks have revised down their economic growth expectations for this year. In theory, a central bank induced recession and record-high fuel prices should lead to lower oil demand growth through demand destruction. In practice, though, demand destruction is still proving elusive. In its latest monthly report, OPEC lifted its global oil demand growth estimate for the second half of this year. Moreover, JP Morgan said last week that global oil demand will increase by a healthy 3.7 mbpd between May and the year-end.

Demand destruction is being delayed by pent-up demand in the post-Covid world. Travellers are proving resilient to record fuel prices, and nowhere more so than in the US. The national average price for US gasoline rose above $5 a gallon for the first time in history yet demand for the fuel remains robust. Based on weekly data from the EIA, gasoline deliveries were higher so far this month at +2.5% y-o-y. People want to travel. Consumers are determined to enjoy their summer holidays before bedding in for what is set to be a tough winter. Not only is there plenty of pent demand for summer travel, but China is also expected to soon return to normal despite news of fresh outbreaks in Beijing. The upshot is that global oil demand is on track to recover to healthy levels in the second half of this year.

Meanwhile, on the other side of the oil equation, OPEC+ efforts to boost output per the monthly plans continue to disappoint. The producer alliance produced 2.7 mbpd below its crude oil targets in May. News of OPEC+ members underperforming their production targets is far from surprising. Western sanctions on Russia and capacity constraints at several other producers have undermined efforts to reach quotas. What is unexpected is that OPEC+ pledged to boost production by more than the originally agreed in July and August. Yet given its history of struggles with production hikes, it is highly questionable whether it can significantly raise output. The odds are that production from OPEC+ is unlikely to improve too much over the summer months.

Staying on the supply front, the likelihood of a revival in the Iranian nuclear deal was dealt a fresh blow last week. The Biden administration slapped fresh sanctions on companies based in Iran. With dwindling prospects of Iranian sanctions relief and thus a meaningful increase in crude oil exported from Iran, undersupply concerns will remain at forefront of traders’ minds.

All things considered, the crude oil complex is set for further tightness. Add to this, the world is running short on refining capacity, and it will take a brave man to bet against oil prices edging higher over the summer months. The weeks-long oil price rally showed signs of reversing last week but the lull is not expected to last long. Supplies will remain tight and continue supporting high oil prices. The norm for ICE Brent is still around the $120/bbl mark. That said, the post-summer period will likely be a different story. Prices will come under pressure as worsening macroeconomic conditions make for additional headwinds for fuel demand. Until then, expect the oil market to grind higher.