Why Is Goldman Sachs Suddenly Bullish On Oil Prices?

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Summary

In its 2016 Outlook report, Goldman Sachs had presented a rather bearish forecast for oil.

Goldman Sachs is now predicting that WTI could reach $50 per barrel levels in the fourth quarter of 2016.

However, it predicts that prices could fall to $45 per barrel by the first quarter of 2017.

In its 2016 Outlook report, Goldman Sachs had presented a rather bearish forecast for oil. The report that came out in January this year stated several factors that might push the oil prices downwards in 2016. Decline in China's economic growth, Saudi Arabia's fixation to control Iran's growing influence, and rising global supply-demand imbalance were some of the main reasons given for the bearish forecast. However, we are almost in the middle of 2016 and oil prices are hovering above $45 per barrel. In its latest report, Goldman Sachs came out with a bullish forecast for crude oil. The markets reacted positively to this report as the Western Texas Intermediate (WTI) went over $47 per barrel on Monday, May 16th for the first time since November 2015. Even United States Oil Fund (NYSEARCA:USO) increased by 2.3% to $50.38 on Monday.

"Rebalancing of the oil market has already started"

Damien Courvallin - oil analyst at Goldman Sachs is now predicting that WTI could reach $50 per barrel levels in the fourth quarter of 2016, as against his earlier call of $45 a barrel. Interestingly, Courvallin was one of the analysts who had earlier predicted that oil prices could fall to as low as $20 a barrel because of the global supply glut. Oil had then bottomed out at $26.19 per barrel in February 2016. "The physical rebalancing of the oil market has finally started. While supply and demand surprised to the upside commensurately in 1Q'16, leaving the market oversupplied by 1.4 mb/d, we believe the market has likely shifted into deficit in May. The 2Q'16 deficit that we now forecast is occurring one quarter earlier than we expected mid-March, driven by both sustained strong demand as well as sharply declining production", said the report.

What does this mean?

Goldman Sachs tries to justify its bullish take on oil by emphasizing on 'sharply declining production' and 'sustained strong demand'. Looking at production, we see that recent the Canadian wildfires have created a supply disruption of around 1 million barrels per day and Nigeria's supply disruption (caused mostly because of militant attacks) have resulted in a decline of around 800,000 thousand barrels per day of crude oil. This means that the oversupply of 1.4 million barrels a day that persisted in the first quarter of 2016 has been easily knocked away by the combined supply disruptions of Canada and Nigeria that are somewhere around 1.8 million barrels a day. Moreover, there can be even more militant attacks in Nigeria and supply disruptions from that region could increase even further. Even the US oil production is expected to grow at around 8.6 million barrels a day in 2016, which is around 9% less than its 2015 peak production levels.

When we look at the 'sustained strong demand', we find that the investment firm has got it right. Last week, I had reported how both EIA and IEA are predicting the global oil demand to increase this year by around 1.4 million barrels a day, with China and India spearheading this growth. Therefore, declining production (supported by supply disruptions) and increasing demand has started re-balancing the oil markets.

Conclusion

I strongly believe that supply-demand rebalancing will push the oil prices up in the coming months. In fact, I predicted last week that oil prices may go beyond $50 in the next 4-5 months. Even Goldman Sachs has now set a $50 level for oil by the fourth quarter of 2016. However, it predicts that prices could fall to $45 per barrel by the first quarter of 2017 as the global supply increases and demand falls down after the end of summer driving season. One thing is for sure, if we look at the US Shale players or the Saudis who both require oil prices to be in the range of $55-$65, the latest Goldman Sachs report is not as bullish as it looks to be.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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