US Fed cuts will not prevent an oil-price crash in 2025

A 13 percent plunge in oil prices in only 10 trading sessions ahead of September’s Federal Open Market Committee (FOMC) reinforces my conviction that the world has entered a global economic slump, led by China, the US and Germany.

Brent and West Texas were the beneficiaries of a respite from Hurricane Francine which closed down offshore rigs in the Gulf of Mexico and reduced production by 671,000 barrels per day, one third the GoM’s output. 

A typhoon in Guangdong province also closed down coastal refineries and LNG terminals in the largest, most industrialised trading province in China.

Francine and the Chinese typhoon then triggered short covering orders from some of the world’s largest leveraged hedge funds, whose algorithm-driven models were hugely short Brent/WTI futures contracts in New York, London, Singapore and Tokyo.

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This is the only reason Brent traded at $72 per barrel and West Texas closed just below $70 per barrel last Friday before the FOMC.

I believe the Powell Fed does not want to panic the markets and will only cut the overnight borrowing rate by 25 basis points, even though US manufacturing is in distress, with the ISM index – the Institute of Supply Management captures purchasing manager expectations – at 46 and new orders even lower at 44.5. 

The cognoscenti on the world’s oil futures, swaps and derivatives exchanges know that global demand for diesel and gasoline has collapsed even in high-growth emerging markets like India. 

A Fed rate-cut cycle will not trigger a trend reversal in the oil market. The path of least resistance in Brent/WTI crude this autumn is thus lower. Why?

One, China is the world's largest oil importer and is projected barely to increase consumption by 200,000 bpd in 2024, due to demand destruction caused by its protracted shadow banking and property crisis and a decline in consumer confidence and discretionary travel spend. 

This is amplified by the arbitrage between natural gas prices at $2/million British Thermal Unit (BTU), which equates to $12-$14 Brent, and the current wet barrel price for the world's two leading light sweet crude benchmarks. Gas is cheap and oil is not – despite the weakness in the latter.

Two, 30 percent of delivery trucks sold in China are now powered by natural gas and not diesel. This has had a catastrophic impact on diesel demand estimated at almost one million bpd in the PRC, or 3.4 percent of the 30 million bpd global diesel demand.

If this trend accelerates and Opec+ does nothing, a 2014 or 2020-scale price crash in Brent is the inevitable endgame. In early 2016, Brent collapsed to $28 a barrel before Saudi Arabia engineered an epic output cut as Opec's swing producer.

In 2020, as the Covid virus raged around the world, Brent plunged to $20 a barrel and WTI oil futures for Cushing Oklahoma delivery were deeply negative. 

Thus the collapse of diesel demand in China is as much due to this price arbitrage or switch to dirt-cheap gas from far more expensive crude oil as it is due to the GDP slowdown in 2024. This arbitrage switch trend will dominate black gold's fate in 2025 and evokes the ghosts of Papa Bear in the global wet barrel market.

Three, geopolitics reinforces the bearish trend in crude oil. A Trump victory is likely to usher in a ‘drill, baby, drill’ ethos in shale, a rapprochement with the Kremlin, an end to the Ukraine war, and potential regime change in Venezuela.  

Caracas is the ultimate prize in Latin America as its Maracaibo Basin has more oil reserves than Saudi Arabia or Iraq. Under a pro-West regime, Venezuelan output can easily surge from its current low of 700,000 barrels to four million bpd, its output in the pre-Chavez era. This would be the biggest game changer in global energy since the evolution of fracking in Texas two decades ago.

• Saudi oil receipts drop to a three-year low
• Kuwait’s oil minister resigns amid energy challenges
• Frank Kane: October presents Opec+ with a quandary

Four, Brazil and Guyana are emerging as global scale offshore producers. Argentina's Vaca Muerta shale basin is comparable in size to the Permian Basin in Texas. The Gaza war and the Iran-Israel confrontation have had no impact on tanker traffic in the Gulf even though Houthi attacks have caused local havoc in the Red Sea.

Five, a Kamala Harris victory is likely to mean more regulatory and environmental restrictions on shale drilling, which would normally be positive for crude oil.

Paradoxically, energy shares in Wall Street do better when the White House is under the control of Democrats rather than the GOP as their anti-fossil fuel stance restricts new supply and boosts market prices. 

This trend will not help Brent even if Mrs Harris wins the election since her environmental policies will negatively impact US natural gas and lower its price as a trapped asset, thus accelerating the China switch trade that has been such a sword of Damocles for diesel demand.

Six, the US/China Cold War means onshoring of advanced manufacturing is a national security imperative for Uncle Sam. This necessitates cheap energy inputs to offset the higher cost of labour relative to China. 

Are we moving toward a world where US shale output rises to 15 million bpd while Opec+ cannot prevent an epic glut in 2025 no matter what deals it cuts in Vienna?

Yes, a Brent price crash to $40 in 2025 is not unthinkable.

Matein Khalid is the chief investment officer in the private office of Abdulla Saeed Al Naboodah and the CEO designate of a venture capital firm. He is also an adjunct professor of real estate investing and banking at the American University of Sharjah