Crude Oil's Rally on U.S.-China Trade Hopes: A Fragile Foundation?

The sudden surge in oil prices in early May 2025 underscores the delicate interplay between geopolitical optimism and market fundamentals. Brent crude futures rose 1.5% to $63.07 per barrel, while WTI climbed 1.7% to $60.12, driven by hopes that U.S.-China trade talks would ease tensions between the world’s two largest economies. Yet beneath the surface, a mosaic of supply concerns, demand uncertainties, and geopolitical risks threatens to undermine this optimism.

The Trade Talks Catalyst
The talks, led by U.S. Treasury Secretary Scott Bessent and Chinese Vice Premier He Lifeng, marked a rare high-level engagement amid lingering trade disputes. Analysts noted that even incremental progress—such as a commitment to “de-escalation” rather than a full deal—sparked buying in oil markets. Traders bet that reduced tariffs and improved access to each other’s markets could boost global demand, particularly in manufacturing and transportation.

However, Bessent’s emphasis on “fair trade” rather than a reset of trade relations tempered expectations. The U.S. Commerce Department’s warning that $1.2 trillion in S&P 500 revenues rely on China further highlighted the stakes: a full-scale decoupling would be catastrophic, but so would a stalemate.

Supply-Side Pressures: OPEC+, Shale, and the Fed
While trade optimism buoyed prices, supply dynamics remain fraught. OPEC+’s decision to increase output by 411,000 barrels per day (bpd) in June 2025 risks exacerbating oversupply, even as U.S. shale production slows. The EIA revised its 2025 U.S. crude output forecast downward by 180,000 bpd, citing falling rig counts and reduced capital spending by shale firms. Diamondback Energy’s estimate of a 10% Q2 rig-count decline underscores this trend, suggesting a structural slowdown in U.S. supply growth.

Meanwhile, the Federal Reserve’s decision to hold rates steady—a move partly enabled by falling oil prices—has stabilized financial conditions. Yet Fed Chair Powell’s acknowledgment of “heightened uncertainty” around inflation and employment adds a layer of risk. A stronger dollar, driven by Fed policy, could undercut oil’s gains by making it pricier for non-U.S. buyers.

Demand Dilemmas: Gasoline Inventories and Geopolitics
On the demand side, the EIA’s report of rising U.S. gasoline inventories ahead of the summer driving season cast a shadow over prices. Analysts like Tamas Varga of PVM Oil note that “the market is pricing in hope, not hard data.” Middle East tensions, including clashes between Israel and Houthi forces, added a geopolitical risk premium, but these conflicts have yet to disrupt physical supply chains.

Analyst Perspectives: Unloved Rallies and Fragile Momentum
Deutsche Bank’s analysis of “unloved rallies”—gains driven by speculative optimism rather than fundamentals—offers a cautionary lens. Such rallies, it noted, have historically persisted despite skepticism, citing parallels to post-pandemic recoveries and the 2023-24 oil bull market. Yet without concrete trade progress, this momentum may falter.

Morgan Stanley warns that a breakthrough in U.S.-China talks must materialize within weeks to sustain oil’s rally. Bessent’s downplaying of expectations—stressing “fair trade” over a reset—suggests such an outcome is far from certain. Meanwhile, Hargreaves Lansdown’s Susannah Streeter highlights the paradox: oil’s rise reflects both supply constraints and trade optimism, but neither is yet definitive.

The Bear Case: Overhangs and Delays
The risks are manifold. First, the trade talks may fail to produce tangible outcomes, as Bessent and He Lifeng face domestic political constraints. Second, Iran’s potential return to oil markets—a possibility if stalled nuclear talks resume—could add another 1 million bpd to global supply. Third, the Fed’s caution on inflation could reverse if oil-driven cost pressures resurface, spurring rate hikes.

Conclusion: A Delicate Balancing Act
Crude oil’s May surge is a testament to markets’ sensitivity to geopolitical tailwinds. Brent’s 1.5% jump and WTI’s 1.7% rise since the talks began reflect a bet on reduced trade tensions and resilient demand. Yet the fragility of this rally is clear. Supply overhangs, slowing shale output, and Middle East volatility mean prices could swing sharply on any setback.

Investors must weigh two competing narratives: one where trade de-escalation sparks a sustained demand rebound, and another where oversupply and geopolitical risks dominate. With the S&P 500’s longest winning streak since 2004 already priced in, the next few weeks will test whether hope or reality prevails. For now, crude’s gains remain tethered to a thread—U.S.-China relations—and markets have a poor record of predicting diplomacy.

In the end, as Deutsche Bank’s “unloved rallies” suggest, oil’s rise may outlast skepticism, but it will not outlast disappointment. The path forward hinges less on rig counts or OPEC quotas and more on whether two superpowers can turn hope into action. The stakes, after all, are as high as the price of oil itself.