$80 oil is sending the market toward demand destruction, Morgan Stanley says

• With winter ahead and a gas crunch in Europe, the demand picture appears promising. But demand destruction could be imminent as prices climb higher, some experts are warning.
• Higher energy prices will also fuel even higher inflation, which poses a significant threat to demand.

The current energy market picture is looking good for oil bulls. 

International benchmark Brent crude passed the long-anticipated threshold of $80 per barrel on Tuesday, though it's since slipped back down to trade at $78.47 as of Wednesday at 10:30 a.m. in London. West Texas Intermediate was trading at $74.73 per barrel around the same time.  

With winter ahead and a gas crunch in Europe, the demand picture appears promising. But demand destruction could be right around the corner as prices climb higher, some experts are warning. 

"Oil prices have disconnected from the marginal cost of supply. Instead, they are travelling to the level where demand destruction kicks in, which we estimate at ~$80/bbl." That's what Morgan Stanley wrote in June, and in a note Tuesday, the bank wrote: "This remains our thesis." 

It added, however, that "the price at which demand destruction kicks in can be fiendishly difficult to estimate. We leave our price forecast unchanged for now but recognise that, on current trends, upside to our bull case scenario to $85/bbl clearly exists." 

Morgan Stanley foresees global oil supply getting tighter, citing an average of 3 million barrels of crude per day of inventory draws in the last month, compared to 1.9 million barrels per day drawn in the preceding months of this year. 

"These draws are high and suggest the market is more undersupplied than generally perceived," the bank's analysts Martijn Rats and Amy Sergeant said.  

Furthermore, flights and transport have picked up, with Flightradar data on commercial flights "closing the gap to pre-covid levels," they said. 

Still, not all the signs are bullish. 

The World Bank said Tuesday that the Delta variant is slowing economic growth in the East Asia and Pacific region, and growth forecasts have been downgraded for most of the region's countries. And China faces a potential slowdown with its Evergrande crisis and a growing power shortage that's hitting factories, homes and supply chains.  

"China's economic troubles are casting a dark shadow on the demand side of the oil coin and hence the price outlook," warned Stephen Brennock, a senior analyst at London-based PVM Oil Associates. 

Higher energy prices will also fuel even higher inflation, which poses a significant threat to demand.

"Rising oil prices have been one of the biggest drivers of inflation," Brennock said in a note Tuesday. "And a worsening inflationary situation will act as a drag on the fragile economic recovery and oil consumption. This brings us neatly onto the issue of demand destruction." 

China and India, some of the world's top oil importers, began selling oil this month from their strategic reserves in an unprecedented move to try to lower crude prices as energy costs surged across the region. While it hasn't succeeded in lowering global prices, it sent a significant message.

"The reason for this turn of events is price," Brennock wrote. "At over $70/bbl, crude appears to have become too expensive for Beijing and New Delhi. … Oil prices hitting $80/bbl will be a severe pain point for these key crude buyers and is likely to undermine import demand."

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