Goldman Sees More Oil Weakness Until China Reopens, Then Even More Upside
Now that today’s flagrant oil market manipulation attempt via a WSJ “leak” early this illiquid morning has crashed and burned with oil trading at session highs after a rollercoaster session that saw oil tumble by $5 and then rebound by even more…
… after the Saudis denied the report attributed to the “group’s delegates” just two hours later as we expected…
Has Saudi Arabia denied everything yet
— zerohedge (@zerohedge) November 21, 2022
… we can focus on the bigger picture, which is mostly dependent on China’s reopening schedule and the G7 Russian oil price cap – especially with Russia saying it won’t sell oil to price-cap nations, a scenario which JPM said could lead to $300+ barrel of oil – and to a lesser extent, the calendar. Here, while the medium-term price trajectory remains somewhat murky, one thing is certain: with even less investment in supply (and with interest rates at levels that make mockery of capex hurdle rates) now than in recent years, over the long-run, prices are going much higher.
That in a nutshell is the summary from the latest Goldman Oil price research note, in which the bank’s chief commodity strategist Jeffrey Currie cut his 2022 Q4 price target by $10 to $100/bbl, while doubling down on his extremely bullish long-term oil price outlook. Below we excerpt the highlights from his note:
Over the last ten years, Brent prices have averaged a c.10% drawdown in November, in what has practically become a Thanksgiving tradition. While it’s tempting to blame a lack of liquidity for another capitulation, we believe the market is right to be anxious about forward fundamentals, due to significant Covid cases in China and a lack of clarity on the implementation of the G7’s price cap.
While confidence remains high in a 2Q23 China reopening and the structural bullish underinvestment thesis, the path between now and next spring remains highly uncertain. China’s Covid cases are at Apr-22 highs, yet, the new policy reaction function is unknown. However, the logic of exponential virus spread, means further lockdowns will likely be required, if full reopening is not feasible. Therefore, we cautiously lower our expectations for China demand by 1.2 mb/d in 4Q22, equivalent to the effective cut recently implemented by OPEC+, the group’s first successful preemptive curtailment.
Meanwhile, Russia oil export flows are being maintained at elevated levels as inventories are drained ahead of the imminent implementation of the EU crude embargo. Consequently, we expect a lagged impact of the embargo on production, raising our expectations by c.0.3 mb/d over 4Q22.
According to Goldman, the net impact of the above is a ~1.5 mb/d loosening of 4Q22 balances, lowering the bank’s 4Q22 Brent forecasts by $10/bbl, to $100/bbl. But according to Currie’s calculations, markets have already priced a 2 mb/d softening over the next 3 months, as these fundamental developments occurred during a seasonally low liquidity period, with discretionary positioning at post-pandemic highs, activating CTA sell triggers, exacerbating the move lower.
To be sure, WTI has notably underperformed, with prompt spreads plunging into contango, as the grade suffered from a unique combination of factors:
(1) a disruption to a USGC pipeline;
(2) soaring dirty tanker rates; and
(3) quality concerns causing WTI to discount sequentially by c.$5/bbl+ from similar grades.
Goldman concludes that until broader macro stability – directly linked to the inevitable Chinese reopening from its artificial “covid zero” policy, which are nothing more than a scapegoat for Xi’s foundering economy – is able to generate an increase in passive flows, the burden of proof remains on fundamentals. To that end, Currie’s advice is to monitor both Russia’s export flows, as well as China’s pandemic response in the coming weeks (if ignoring WSJ hit pieces). More importantly, for longer-term investors, “the current sell-off provides an opportunity to add length on yet another speed bump that will come to pass.” Here’s why:
While the market has rightfully reassessed year-end fundamentals more bearishly, spot balances have pivoted into deep draws since late October of c.-1.5 mb/d versus a 2017-19 average build of +0.5 mb/d (Exhibit 19). This has been driven by both landed crude (ex China), as well as oil on water (ex-Russia origin). However, with Russia supply and China demand both tracking bearishly on our high frequency modeling, these draws are indicative of robust spot demand (ex-China). This is corroborated in our global hard current activity indicators, reflecting realized demand, versus soft activity indicators which tend to be more forward-looking (Exhibit 23).
Global oil stocks remain at very depleted levels, just 100 mb above the YTD lows. Moreover, OPEC+ has just started its preemptive 2mb/d quota cut (worth 1.2 mb/d in actual production in our view), into a market that was already in a seasonally-adjusted deficit (Exhibit 21). This is all despite Russia maintaining production just below pre-war levels.
The underlying trends in the balances therefore seem intact, in our view, with energy equity price action a testament to this. China’s lockdowns, like all previous waves, will come to pass, and the country should reopen fully domestically next year. We still believe Russian production will decline sequentially c.0.6 mb/d from here, with risks of a deeper, more abrupt disruption, still present. Thus, while we downgrade our 4Q22 Brent forecasts by $10/bbl (to $100/bbl), we maintain our forecast for $110/bbl Brent next year, with risks still skewed higher should inventories fully deplete once again. This could occur in 1H23 if OPEC+ maintains its current quotas and global activity and employment remain at high levels.
Therefore, for longer-term investors, the current sell-off provides an opportunity to add length on yet another speed bump that will come to pass. From a tactical perspective, uncertainties abound, while discretionary positioning is still long and CTAs flows will be selling, leaving risks skewed lower in the near-term.
More in the full report available to pro subs.
Mon, 11/21/2022 – 15:00