By Rupert Hargreaves
The 'green shoots' of rebalancing are starting to show through in the oil market according to a Goldman Sachs research report on The New Oil Order published at the end of last week.
Based on today's trading action, however, it doesn't look as if the market wholly believes that Goldman's 'green shoots' actually exist. Nonetheless, the bank's analysts make some interesting points in the report, a copy of which has been reviewed by ValueWalk.
Oil market: Goldman's 'green shoots'
Goldman's oil report is titled "the good, the bad and the ugly," and it looks at these three traits (good, bad and ugly) of the market and how they may influence prices going forward.
The good feature is the aforementioned 'green shoots' of rebalancing. Thanks to prices averaging $32/bbl year-to-date, producer guidance in both the US and the rest of non-OPEC is finally pointing to sequential production declines. US oil production declines accelerated during December of last year, falling by 150,000 bbl/d month-on-month. February data pointed to declines of 100,000 bbl/d.
According to Goldman's equity analysts, E&P 2016 production guidance is indicating overall US production declines of 600,000 to 830,000 bbl/d for the full year - exceeding Goldman's initial 575,000 bbl/d decline forecast.
Non-OPEC production outside the US is also declining. Goldman's figures show output from non-OPEC countries is set to fall by 335,000 bbl/d during 2016, up from the initial 100,000 bbl/d estimate.
On the demand side, there are also signs of strength. With Brent crude at $40/bbl Goldman estimates that global GDP can grow by 3.25% this year leading to strong demand growth of 1.15 mb/d during 2016.
Unfortunately, the above 'green shoots' are far outweighed by 'the bad' elements weighing on the oil market. These can be broken down into six categories:
- Demand growth still relies on emerging market economies. If Latin American growth, in particular, splutters, Goldman's forecast for demand growth could be revised lower.
- While the oil market is being spared 2mb/d in additional oil supply from OPEC production disruptions, production in regions like Syria, Kurdistan, Libya and Yemen is now close to zero and only skewed to the upside.
- Non-OPEC US declines are all about the base. Producers are ready to bring production back online if oil prices stage a recovery. Canadian producers, for example, have forecast an oil price of $36/bbl for this year and have budgeted accordingly. However, several producers have commented that they would be ready to increase production if oil prices returned to $40/bbl.
- US production will also respond to higher prices. Many producers have said that they will be willing to bring production back online should prices near $45/bbl. Moreover, while Goldman's rig count monitor points to US production declining by 620,000 bbl/d this year, this doesn't take into account the current backlog in the Permian, Bakken and Eagle Ford plays. Backlog well in these regions could yield as much as 620,000 of production for six months, enough to produce 9.8 mb of crude stocks. In other words, if WTI prices returned to $45 the US E&P sector will bring a wave of supply back online decimating prices once again.
- The debt markets have closed too many oil producers with no high-yield issuance taking place this year and in five of the past seven months. But access to funding is far from closed. 16 equity issuances have taken place so far this year in the US. Including three investment-grade oil sector debt issuances, these capital raisings total $14 billion of new funding - that's excluding Exxon Mobil's (NYSE:XOM) $12 billion debt issue.
- Macro issues are the final factor that could weigh on a recovery in oil prices. Global economic expectations have brightened during recent weeks as commodity prices have rallied and inflation has started to return. However, it remains to be seen if these positive economic tailwinds will continue.
So, we've had the good, and the bad the one about the ugly? Well, the really ugly fact about the oil market is that storage tanks all over the world are reaching record levels of capacity. Goldman believes that it's likely there isn't sufficient storage capacity to accommodate a large declining refinery runs.
Assuming the most optimistic case that production is indeed set to decline significantly this year, Goldman believes that the oil market will shift into deficit during the third quarter of this year and in victories will begin to be drawn down. Only time will tell if this forecast has any weight behind it.