Goldman Bullish Despite Steep Correction in Oil Prices
Goldman Sachs continues to be bullish on oil despite the most recent market turbulence that saw oil prices plummet after reports that Saudi Arabia and Russia are discussing lifting the pact’s production by as much as 1 million bpd to address supply concerns.
The U.S. investment bank reiterated its forecast for Brent Crude at $82.50 in the third quarter this year, due to expectations that global demand growth will stay high even with Brent at $80, and that infrastructure constraints would delay record U.S. crude oil volumes to access the market.
“The current level of the market deficit, the robustness of the demand backdrop, and the rising levels of disruptions all set the stage for inventories to fall further,” Goldman Sachs analysts wrote in their recent report, as carried by Bloomberg.
At the beginning of this month, Goldman Sachs forecast that increased geopolitical tensions in the Middle East, plunging Venezuelan production, and the U.S. withdrawal from the Iran nuclear deal could push Brent Crude prices to $82.50 a barrel by the summer.
A couple of weeks later, Goldman warned that hedge funds and other money managers are wrong to bet against oil, after they started to reduce their record long positions in the six most important petroleum futures and options contracts.
Now Goldman looks unfazed by the growing talks of OPEC and Russia possibly easing the cuts to ‘stabilize’ the oil market and ‘ease consumer anxiety’.
According to the investment bank, even if OPEC and allies increase production by 1 million bpd, this would only offset involuntary production declines. A gradual increase of those 1 million bpd would still result in an oil market deficit in Q3 2018, and plunging Venezuelan production and possible Iran supply disruptions would partially offset that 1-million-bpd increase, Goldman says.
“Historically, oil prices have declined after the announcement of OPEC production increases, however, when these occurred in a strong demand environment like today, prices were on average 8 percent higher than pre-announcement two months later,” Goldman analysts wrote. – Tsvetana Paraskova
This Change Could Send Oil Prices Higher
Iran and Venezuela have dominated the oil market discourse for a while and will continue to do so in the coming months. Fears of supply shortages amid a tighter market have stoked an oil price rally that saw Brent Crude hitting $80 a barrel last week.
But an upcoming regulation that analysts have called “the biggest change in oil market history” and the “the most disruptive change in the refining industry” is lurking just around the corner, and experts say that it will drive crude oil prices higher as it will fundamentally shift the demand pattern for fuels.
The regulation concerns significantly limiting the sulfur content in the fuel that ships use, in a bid to curb emissions from the shipping industry.
The International Maritime Organization (IMO) has set January 1, 2020, as the starting date from which only low-sulfur fuel oil will be allowed to be used for ships. The global sulfur limit on fuel oil will be set at 0.50 percent m/m (mass/mass) in 2020, a significant cut from the 3.5 percent m/m global limit currently in place.
The regulation will send demand for middle distillates such as diesel and marine gasoil soaring, and refiners will have to shift some of the products they will be processing from crude oil, analysts concur.
Middle Eastern crude oil producers could be one the biggest losers from the new regulation, because they pump high-sulfur crude, Amrita Sen, chief oil analyst at Energy Aspects, told CNBC this week, discussing the outlook for oil prices.
“That is very important because Middle Eastern producers lose out heavily from that because their crude tends to be very high sulfur,” Sen said, noting that the shipping fuels regulation is the “biggest change in the history of the market.”
The stricter regulation on the fuels used by the shipping industry will result in booming demand for middle distillates that would boost crude oil demand by additional 1.5 million bpd, potentially sending oil prices to as high as $90 a barrel in 2020, Morgan Stanley said last week.
In fuel oil prices, the forward curve has not yet fully priced in the regulation, according to research from SP Global Platts Analytics last month.
“This is going to be the most disruptive change to hit the refining industry in its history,” Chris Midgley, global head of Platts Analytics, said. “Unlike other specification changes seen by the industry, this isn’t a little bit of tweaking.”
According to Rick Joswick, managing director for downstream oil analytics at Platts, the forward curve for middle distillates currently shows little change between 2019 and 2020—underestimating the impact of the new rules.
“The market has not appreciated yet the degree and scope of these changes,” Joswick said.
The timing of the new regulation will coincide with the effect on supply from the underinvestment during the oil price crash and the strength in demand, suggesting that the “era of ‘lower for longer’ oil prices is dead”, Energy Aspects’ Sen and Yasser Elguindi wrote in a commentary in the Financial Times this week.
Over the past month, the five-year forward oil prices that generally trade in a much narrower band than front-month futures have rallied more than the prompt prices.
“While there has been breathless attention paid to prompt Brent prices climbing to $80 a barrel for the first time since 2014, what has received less attention is that the entire Brent forward curve is now trading above $60, including contracts for delivery as far out as December 2024. This development is an important psychological milestone for the oil market. The market is, in effect, saying that ‘lower for longer’ is dead,” Sen and Elguindi wrote.
Looming shortages of supply and strong demand will combine with the marine fuel regulation in 2020 to put additional pressure on the physical oil market. Demand for diesel and ultra-low sulfur fuel is expected to jump by 2 million bpd-3 million bpd, Energy Aspects analysts noted.
“Nothing ever moves in a straight line, but the broader oil market is perhaps not prepared for what will happen to oil prices over the next couple of years,” they concluded. – Tsvetana Paraskova
Any Chances of more Corrections in Oil Prices?
Zerohedge: The last four days have seen WTI Crude prices plunge almost 10% from their cycle peak near $73 to a $65 handle overnight.
This is the longest run of losses in almost four months as Saudi Arabia and Russia said they are discussing raising output to ease consumer anxiety after prices jumped to levels last seen in 2014.
Saudi Arabia and Russia signaled they’ll restore some of the output they cut as part of a deal between OPEC and its allies that took effect in January last year. Potential opposition from several producers could complicate the group’s effort to reach a consensus when it meets next month in Vienna.
“It was always going to be a tricky announcement of when to ease production cuts,” said Ole Sloth Hansen, head of commodities research at Saxo Bank A/S in Copenhagen. “Oil was already on the defensive.”
However, we have seen all this before – We are now at the peak of a similar shape and timed move as the 2008-2011 rebound…
After the $115 peak in 2011, oil ranged between $115 and $75 for 30 months. A similar dynamic this time would suggest a $70 to $50 multi-year range… which fits with what Russian President Vladimir Putin said last week – that oil prices at $60 fully suit Russia and the country doesn’t want them to spiral higher. Anything above that level “can lead to certain problems for consumers, which also isn’t good for producers,” he said. OPEC and his nation don’t plan to stick to existing output cuts, he said.
And while Goldman Sachs’ fundamental views are that oil prices will strengthen:
Saudi Arabia and Russia signaled today that they would likely ease their production cuts in the second half of the year. Comments by their Energy Ministers suggest that such a decision would be driven by concerns that high oil prices start to impact global economic activity and was spurred by pressure from the US and China to bring barrels back online. Oil prices have sold off on these comments.
While today’s announcement lifts some of the uncertainty on whether and when OPEC and Russia would increase production, we do not view this as a material change to our bullish oil outlook:
1. this response is occurring because of a tight oil market
2. its magnitude is still uncertain but, even at 1 mb/d, such an increase would simply offset the involuntary production declines with the group still committed to restraining output,
3. even at 1 mb/d, its gradual implementation would leave the market in deficit through 3Q18,
4. ongoing disruptions in Venezuela and potential losses from Iran are likely to partially offset this higher supply, as well as
5. require further increases in production in 2019, which will further reduce already limited spare capacity next year.
Despite greater clarity on the OPEC/Russia response function, today’s headlines by no means suggest the oil market is on a smooth path to rebalancing. Instead, the current level of the market deficit, the robustness of the demand backdrop, and the rising levels of disruptions all set the stage for inventories to fall further all the while OPEC spare capacity is drawn down. As a result, even if today’s headlines provide a cap on prices in the short term, we reiterate our $82.5/bbl 3Q18 Brent price forecast (which effectively embedded such a supply response) and still see risks to prices in 2H18-2019 as skewed to further upside. In fact, history shows that increases in OPEC production quotas in a strong demand environment (like today) are followed by higher prices in the subsequent months.
Goldman’s technical team sees significant downside as they warn that crude oil posted a bearish key week reversal…
WTI Crude tested and held the 1.618 extension target at $71.76…
This 71.76 level was the target for a 5th of 5-waves from Jun. ‘17 lows. It’s since posted a bearish key weekly reversal against negatively diverging oscillators. The market hasn’t posted one of these patterns (from a local high) since ‘13.
Bottom line, there’s a good chance the market has completed a 5-wave sequence here, which means that it’s due to start a corrective process.
A short-term top is likely in place, it could take some before WTI is able to resume its uptrend.
Wedges are classic ending patterns that often result in sharp/impulsive breakouts. The breakout thus far has been pretty textbook.
The next congestion area to note is 66.8066.31; includes 23.6% from the Jun. ‘17 low.
The wedge itself suggests potential to retrace the full extent of its ascent to 61.73, near 38.2% retrace 62.23.
View: Next congestion area below 66.80-66.31. Scope to retrace as much as 62.23-61.73.
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