A deepening trade war between the world's two largest economies is bad news for the oil business.

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Oil gets clobbered as trade war fears mount

May 23, 2019 - 4:15 pm
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Related: Expert says root of US-China trade dispute lies in domestic politics

By Matt Egan, CNN Business

(CNN) -- A deepening trade war between the world's two largest economies is bad news for the oil business.

US oil prices plummeted nearly 6% to a 10-week low of $57.91 a barrel on Thursday as fears about the US-China trade standoff intensify in global financial markets.

Crude, which started the day above $61, suffered its worst day since the Christmas Eve meltdown on Wall Street. Oil has now plunged 13% since closing at $66.30 a barrel a month ago, delivering a fresh reminder of the boom-to-bust nature of the oil market.

Analysts blamed the sharp selloff on both the trade war jitters that sent the Dow tumbling more than 400 points on Thursday and evidence that excess oil barrels are starting to pile up.

"The recent stock builds coupled with fears of a global economic slowdown has the market in risk-off mode at the moment," said Ryan Fitzmaurice, energy strategist at Rabobank.

Soaring stockpiles

The oil selloff began on Wednesday after the US government revealed a surprise surge in crude inventories. Oil stockpiles have soared by 37 million barrels over the past nine weeks to the highest level since July 2017, according to ClipperData.

That raised the possibility of another supply glut forming in the oil market, like the one that sent crude crashing into a bear market late last year.

"Traders and analysts are getting antsy," Fitzmaurice said.

Investors rushed to dump shares of oil drillers, with Hess and Devon Energy plunging more than 7% apiece. Even larger oil companies like ExxonMobil and Chevron fell sharply.

Just a few weeks ago, oil prices were on the upswing, supported by solid economic growth, easing trade tensions, US sanctions Venezuela and Iran and rising tensions in the Middle East.

However, much like the stock market, investors are coming to grips with the idea that the US-China trade war might get worse before it gets better. That would slow economic growth, hurting demand for the crude oil that powers the global business.

"Crude oil demand fears are a function of global economic growth concerns associated with tough tariff rhetoric," said Ben Cook, portfolio manager at BP Capital Advisors.

Bracing for more tariffs

Nomura warned in a report on Thursday that there is a 65% chance that the Trump administration carries through on its threat to impose tariffs on all remaining US imports from China.

"President Trump appears to have concluded that maintaining a hard line against China is preferable to striking a quick, narrow, deal," Nomura chief US economist Lewis Alexander wrote in a note to clients.

Lewis added that there is a "rising risk" tariffs will remain in effect through the end of 2020.

Even before new tariffs get imposed, the existing ones have already dinged economic growth.

Business activity "slowed sharply" in May due to trade war worries, IHS Markit said in a report on Thursday. The firm's US business activity index dropped to a three-year low and new orders for manufacturing declined for the first time since August 2009.

Of course, oil prices could rapidly rebound if US-China trade tensions ease and the two sides move closer toward an agreement.

US sanctions on Iran and Venezuela have sidelined a significant amount of OPEC supply. That's on top of deep output cuts already implemented by OPEC and its allies. The producers have signaled they're in no rush to increase supply — and the latest selloff will only bolster that position.

On the other hand, the energy market could come under further pressure if the trade war continues to escalate.

Morgan Stanley warned that investors may be "underestimating" the fallout from trade tensions.

"We see the global economy headed towards recession" if the US imposes a 25% tariff on all US imports from China, Morgan Stanley chief economist Chetan Ahya warned in a report published on Monday.

The specter of a global recession would lay the seeds for a much deeper plunge in oil prices.

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