Crude oil is now picking up steam for the wrong reasons as recession fears multiply. Recently, Citigroup laid out a particularly bearish outlook for “black gold” should the world suffer an economic downturn, boding poorly for the benchmark exchange-traded fund United States Oil ETF (NYSEARCA:USO). During afternoon trading, the USO ETF finds itself down almost 10%.
In a report issued on Tuesday, Citigroup issued a dire forecast that, if a global recession emerges, oil prices might drop to $65 per barrel by the end of 2022. Further, the rate could drop to $45 per barrel by the end of 2023. While Citi doesn’t believe the U.S. will slip into a recession, in its view, investors shouldn’t ignore the potential consequences.
“For oil, the historical evidence suggests that oil demand goes negative only in the worst global recessions,” wrote Citi analysts, which included Ed Morse and Francesco Martoccia. “But oil prices fall in all recessions to roughly the marginal cost.”
The sharp pivot in sentiment places a bright spotlight on the USO ETF. An exchange-traded fund, USO’s objective is to reflect the daily changes (on a percentage basis) of crude oil, specifically the light sweet variety.
USO ETF Hits the Sweet Spot
Instinctively, the counterargument against lower oil prices is “Russia, Russia. Russia.” One of the devastating consequences of its invasion of Ukraine is that, per the International Energy Agency, Russia is among the top producers and exporters of oil.
As a result, U.S.-led sanctions against Moscow have contributed to sharply rising energy prices as a large portion of global supplies have effectively been shelved. Nevertheless, when it comes to crude oil, Russian exports do not represent a pure catalyst.
Although Russia produces several different kinds of oil, its main export blend is called Urals – a medium sour crude type. Urals falls somewhere in the middle between heavy and light oils. Industry players highly value the latter type because it requires less processing. On the other hand, sour crude has more sulfur and carbon than light crude and requires more refining, incurring additional costs.
Therefore, a theoretical lifting of sanctions and an inflow of Urals won’t be a perfect panacea for high prices. Demand for light crude will still take precedence. Under this context, the erosion of the USO ETF is worrisome as it implies fears of intense economic pain.
The Economy Is the Ultimate Arbiter
While Russia represents an easy culprit, Citigroup is arguing that the health of the economy will likely be the ultimate arbiter for the USO ETF and other oil-related investments. Historically, major downturns have devastated demand for crude.
Most notably, the 2008 financial crisis saw the price of Brent crude dip from an average of $138.40 per barrel in June 2008 to just under $36 in December of the same year. Later, in 2014, weakening of global demand for petroleum – particularly from China and Europe – again devastated oil prices.
With similar concerns ringing in the air, Wall Street has applied a pessimistic view on the USO ETF. Therefore, investors will need to exercise vigilance before moving forward.
On the date of publication, Josh Enomoto did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.