Goldman has done it again. Two days after the central banker-incubator cut its year end price target from $50 to $43, admitting the previously anticipated rebalancing will take longer to achieve, and now expects “a global surplus of 400 kb/d in 4Q16 vs. a 300 kb/d draw previously”, and followed the next day by a report in which it said that not even an OPEC deal would stop oil going lower, overnight the very same analyst, just 24 hours after saying the opposite, Goldman’s Damien Courvalin said that the OPEC agreement will “likely provide support to prices, at least in the short term” and added that the announced production quota should boost the price of oil by $7/bbl – $10/bbl. Again: this is two days after cutting the 2016 price target by $7, and one day after saying an OPEC deal would have no impact.
Still, trying to avoid looking like a total flip-flopper, Courvalin adds that “at the historical average 4.8% production beat relative to quotas, this target would be 33.7 mb/d, above current production levels. It has historically taken a fall in oil demand to ensure quota compliance, as in that case, production is forced lower by a decline in refinery intake around the world. This is not the case today with resilient demand growth” and said that “we maintain our year-end $43/bbl and 2017 $53/bbl WTI price forecasts given: (1) uncertainty on this proposal until it is ratified, (2) likely quota beats if ratified, (3) potential for production above our cautious forecasts in areas of disruptions (as was the case today in Libya and KRG), and (4) our conservative supply forecasts outside of OPEC for next year.”
Then again, the only thing that will be stuck in algos’ random access memory is that Goldman now expects oil to rebound by up to $10/bbl, which may explain why oil is now rolling over.
Here is Goldman’s full note for those who care:
OPEC buys time
OPEC members agreed to limit output today, although no quotas were formally set. This agreement is the first since the oil bear market started in 2014 and as such will likely provide support to prices, at least in the short term. However, we maintain our year-end $43/bbl and 2017 $53/bbl WTI price forecasts given: (1) uncertainty on this proposal until it is ratified, (2) likely quota beats if ratified, (3) potential for production above our cautious forecasts in areas of disruptions (as was the case today in Libya and KRG), and (4) our conservative supply forecasts outside of OPEC for next year.
OPEC members agreed today in Algiers to reduce production to a range of 32.5 to 33.0 mb/d, down from 33.2 mb/d in August (based on OPEC secondary sources). As of now there are no further details and the agreement is scheduled to be ratified at OPEC’s next official meeting on November 30. This agreement is the first since the oil bear market started in 2014 and as such will likely provide support to prices, at least in the short term. However uncertainty is set to remain high in coming months, with so far no comments from the Saudi minister. Further, the Iraq minister commented that secondary sources for oil production are too low, with his country’s output potentially 300 kb/d higher than such measure implies, a gap of nearly half of the proposed production cut.
If this deal follows the proposal made by Algeria as reported by Bloomberg this morning, it would leave Libya and Nigeria exempt, feature a production target for Saudi Arabia, allow for some growth in Iran and Venezuela and require a 1.6% production cut elsewhere relative to average January-August production levels.
Through 2017, such a proposal would keep production 480 to 980 kb/d on average below our forecast. Strictly implemented in 1H17 and all else constant, the production quotas announced today should be worth $7/bbl to $10/bbl to the oil price. However, at the historical average 4.8% production beat relative to quotas, this target would be 33.7 mb/d, above current production levels. It has historically taken a fall in oil demand to ensure quota compliance, as in that case, production is forced lower by a decline in refinery intake around the world. This is not the case today with resilient demand growth.
We reiterate our year-end $43/bbl and 2017 $53/bbl forecasts given: (1) uncertainty on this proposal until it is ratified especially as it relates to Saudi cuts and Iran caps, (2) likely quota beats if ratified, (3) upside surprises to disrupted production as announced today (Libya, KRG) with potential for more given our cautious forecasts in these countries, and (4) our conservative supply forecasts outside of OPEC for next year. Since we see risks to production from countries not targeted by today’s quota as skewed to the upside, we view a strict implementation of today’s OPEC proposal as normalizing the risks around our projected price path.
- Today’s proposal does not impact our expectation for weaker fundamentals in the coming months: (1) the deal does not impact current production as it is scheduled to be finalized at the November 30 meeting, and (2) we learned today that production in Libya/Iraq is currently 180 kb/d above our expectation.
- Longer term, we remain skeptical on the implementation of the proposed quotas, if ratified. Strict implementation of today’s deal in 2017 would represent 480 to 980 kb/d less output than we forecast. However, our forecasts assume little reversal in the c.1.0 mb/d of short-term disrupted production, with recent data for these countries already putting that forecast at risk. Further, we have remained cautious on the delivery of new projects outside of OPEC next year, with a combined 400 kb/d lower forecast vs. guided deliveries. The net of all these risks is close to zero, on our estimates, instead of skewed to higher production before today’s quota announcement. As a result, we reiterate our $43/bbl year-end forecast as well as our $53/bbl for next year.
- Our conviction that OPEC production cuts will be ineffective long term is rooted in our view that the flattening of the oil cost curve created by shale will lead to a loss of pricing power by low-cost producers, leaving them with only volume growth to sustain fiscal revenues. As a result, if this proposed cut is strictly enforced and supports prices, we would expect it to prove self defeating medium term with a large drilling response around the world. This is what occurred following the January 1987 OPEC production cut which led to a rebound in non-OPEC onshore rigs before prices sold off again setting the stage for a decade long steady increase in OPEC drilling.
Exhibit 1: No formal proposal has been announced except for a headline production level. The below table illustrates the proposal made by Algeria ahead of the meeting.
Crude oil production (thousand barrels per day)
Exhibit 2: Compliance to quotas is historically poor, especially when oil demand is not weak
OPEC production of countries under quota vs. their production target (lhs); Year-over-year change in global oil demand (rhs). In thousand barrels per day
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