Just a day after no lesser world-renowned newsletter writer than Dennis Gartman went full bull-tard of crude oil (in $29.95 terms), Goldman Sachs has come out with a "lower for longer" warning about the crude complex noting that the gains have been exacerbated by still large short positioning and the break of key technical levels. Despite the magnitude of this rally, Goldman does not believe that data releases over the past week suggest a change in oil fundamentals. In fact, high frequency data continue to point to an oversupplied market despite a gradual decline in US production.
As Goldman Sachs details,
Oil prices have rallied sharply since last Friday (October 2), reaching their highest level since August on Wednesday, October 7, before receding to close at $47.8/bbl. While this rally has occurred alongside a broader re-risking across assets after last week's US non-farm payrolls release, the oil move has been larger, exacerbated by still large short positioning and the break of key technical levels.
Despite the magnitude of this rally, we do not believe that data releases over the past week suggest a change in oil fundamentals. In fact, high frequency stocks continue to point to an oversupplied market despite a gradual decline in US production. Further, while a Fed on hold could offer some reprieve to the EM rebalancing, this decision would ultimately be driven by weaker underlying activity, leaving risks to oil demand and our forecast as skewed to the downside. Net, we expect this rally to reverse and reiterate our forecast for lower prices for longer.
Oil bounce correlated with move across assets post NFP and fueled by oil positioning and technicals
Oil prices have rebounded sharply since Friday, from a WTI pre-NFP low of $44.0/bbl to an intraday high of $49.7/bbl on October 7 before closing at $47.8/bbl. The rally started after the disappointing US September employment report and a lower probability of a Fed rate hike in 2015. As a result the 7.1% rebound in oil prices has coincided with a cross-asset recovery in EM-exposed assets such as EM commodity producer FX (BRL +4.3%) and equities (MSCI EEM +7.4%).
This rally is reminiscent of the late August surge, and was likely again exacerbated by both positioning and technicals. While net speculative length on Brent and WTI has increased since late August, it remains low with Brent short positions only slightly off their peak. The rally further took prices through (1) their resistance level of $48.0/bbl which had held since early September and (2) WTI's 55-day moving average.
Oil fundamentals unchanged over the past week
Importantly, we view the oil data releases that have occurred since Friday as still consistent with our fundamental forecast of a still oversupplied global market. As we laid out in our September 11 "Lower for even Longer" oil forecast update: (1) the global oil market is currently well oversupplied, (2) this oversupply is driven by strong production growth outside of the US with Lower 48 production already declining and gradually tightening light US crude balances, (3) low prices are required in 2016 to finally bring supply and demand into balance by year-end and sustain a US production decline of 585 kb/d next year, and (4) although demand growth has surprised to the upside this year at 1.6 million b/d growth, risks are clearly to weaker demand growth in 2016. We view the data released over the past week as consistent with this framework:
1. The Baker Hughes US weekly rig count last Friday pointed to the largest decline in rig count since May 1, down 26. This suggests that our forecast of $40-45/bbl WTI prices is likely appropriate to achieve a 2016 decline in US production. However, it needs to remain in place to achieve our forecast 2016 decline of 585kb/d, as the current rig count only implies US production declining in 2H15 by 250 kb/d and remaining sequentially flat in 2016. It is noteworthy in that respect that the EIA Short Term Energy Outlook published Tuesday (October 6) featured a more modest 2016 US Lower 48 production decline than last month (at an unchanged oil price) as spending shifts from exploration to production in the Exploitation phase of the oil supply cycle. Further, funding markets have not yet shut, with borrowing base redeterminations appearing so far accommodative and US E&Ps able to raise $1.5 bn in the last three weeks.
2. The EIA weekly statistics released on October 7 showed that despite lower production and lower crude imports, the US remains in surplus with a large crude and gasoline stock build last week. On aggregate for the month of September, the US stock build was 7.3 million barrels larger than seasonal for crude and main products, in particular gasoline. Similarly, high frequency stocks in Europe, Singapore and Japan also point to larger than seasonal stock builds last month.
3. Outside of the US, the Baker Hughes September international rig count released on October 7 was up, driven by higher activity in the Middle East (with core OPEC including Saudi Arabia up 5 rigs) and Latin America (with Argentina and Venezuela at 1-year highs). Further, September oil production data in Russia and Brazil (released since early October) featured sequentially higher production to new record highs for both countries (by 180 kb/d).
4. Estimates of September OPEC production have started to come in and point to production near their August highs, with growth in Iraq/KRG helping offset the expected seasonal decline in Saudi production. This strength in Middle East flows is consistent with the recent increase in freight rates as well. Finally, Saudi Aramco released its November Official Selling Prices on Friday. The pricing into Asia was weaker than required by competing grades such as Cabinda, which does not point to strong Asian demand with Singapore complex margins off their recent highs as well.
5. There have been several headlines of geopolitical tensions in the Middle East in recent days as well but the activities remain far from producing regions with production disruptions in the region already high and, as a result, risks skewed to more supply (Libya, Yemen, Iran, Neutral Zone).
Still lower for longer
Net, we view the recent rise in oil prices as mostly positioning and macro driven, with little fundamental underlying support. We continue to view the oil market as oversupplied and with low prices required to achieve the sufficient rebalancing in 2016. And if the Fed's potential dovish shift has been one of the catalysts for the rebound in prices, we view this in fact as a bearish development as weaker activity in the US and in EM economies leaves risk to our demand forecast skewed to the downside.
