Tuesday, May 9, 2017

Goldman Says Oil Prices On The Brink Of ‘Capitulation’

Is Goldman rethinking its forecast for Brent crude at $50 a barrel?

By Mark DeCambre
May 9, 2017

After crude-oil prices took a beating over the past week, falling to their lowest level since before OPEC-led a deal to curb output in November, analysts at Goldman Sachs say crude may reaching a “capitulation” point.

In a research note dated Friday, Goldman commodity strategists, headed by Damien Courvalin and Jeff Currie, said their 2017 forecast for Brent crude oil trading on London’s ICE exchange LCON7, +0.14% to hit $50 a barrel could be in jeopardy, if the prices continue to come under pressure:

Net, the faster decline in long-term oil prices than we expected this year is a clear downside risk to our spot price level forecast, even if it helps slow US production growth and achieve the inventory draws and the rotation of the forward curve into backwardation that we forecast.

Goldman is referencing the current and future relationship between near-term and the long-term price of oil. A faster decline in contracts in the future may result in more oil being pushed out into the market. Higher prices for oil for future delivery than spot prices—a situation known as contango—tends to encourage crude participants to store oil with the expectation of selling the commodity in the future.

On Friday, West Texas Intermediate crude oil trading on the New York Mercantile Exchange CLM7, +0.06% the U.S. benchmark, logged a weekly decline of 6%. Prices on Thursday marked the lowest settlement since Nov. 29—the day before the Organization of the Petroleum Exporting Countries announced an agreement to limit production by 1.2 million barrels a day.

However, an unrelenting ramp up by U.S. shale-oil producers is being widely credited with the recent downturn in price action for oil, which peaked in late February.

Goldman’s analysts also see U.S. output pressuring oil (see Goldman’s chart below):

Goldman cites two other key reasons for the recent tumble in the commodity complex, including high-grade copper HGN7, -0.42% and iron ore: A China-fueled sell-off in base commodities, that was easing on Friday, and technical trading that has exacerbated the sharp selloff in U.S. benchmark oil and its European counterpart:

Given the lack of any significant oil data releases on the day, we see two forces at play in this sell-off: (1) a follow through on the sharp declines in copper and iron ore the day before on concerns over growth in China, and (2) once again, the influence of technicals and positioning.

Brent crude on London’s ICE Futures exchange LCON7, +0.14% is down nearly 6% for the week.

Goldman writes that although overall stocks have retreated, they may not be declining as fast as the analysts had forecast, which could weigh on prices.

Despite this sharp move lower in prices and timespreads, our tracking of the oil market rebalancing suggests that the month of April featured further progress in reducing the inventory overhang, although at a pace short of prior consensus expectations.

Adding to those concerns, a reading of rig counts by Baker Hughes Inc. BHI, +0.25% showed a 16th straight weekly increase in rigs drilling for oil, suggesting that shale producers in the U.S. may continue to ramp up production, fueling concerns of a renewed glut in crude.

Crude’s decline on Thursday helped to keep the S&P 500 index SPX, +0.00% and the Dow Jones Industrial Average DJIA, +0.03% near break-even levels, with the benchmarks tilting higher in Friday trade.

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