Goldman Estimates Lost Libyan Production Would Require Over Half Of Spare OPEC Capacity To Replace Yet Lowers WTI Target To $97.50

Goldman's David Greely released a crude update factoring in the Libyan revolution in his latest estimates. As it hit the tape ahead of the force majeure announcement later in the date, the predictions in it are especially relevant as pertain to future crude price dynamics. Specifically: "We expect Libya’s crude oil production to reach 1.6 million b/d in 2011, 1.8% of global supply. Should this production be lost to the market, it would require over half of OPEC’s spare capacity to replace. This would dramatically pull forward the return to a structural bull market that we saw occurring in 2011H2 and 2012. Already, the spread of political instability to Libya has sent Brent prices to a post-financial crisis high, close to our 12- month target. The continuing spread of protests through North Africa and the Middle East presents a clear upside risk to our forecasts." And while the focus on Goldman's report is on the spread between WTI and Crude, a topic beaten to death previously, and where the firm sees it going, the more important observation is Goldman's updated price forecasts for Crude and WTI. There are as follows: "We are lowering our WTI-Brent spread forecast to -$5.50/bbl, -$4.50/bbl, and -$3.50/bbl on a 3, 6 and 12-month horizon. This lowers our WTI price forecasts to $97.50/bbl, $100.50/bbl and $103.00/bbl and raises our Brent forecasts to $103.00/bbl, $105.00/bbl, and $106.50/bbl on those horizons." For those who are confused by the disconnect between the first part of this Goldman's argument (price surge on Libya), and the second (WTI price drop due to a spread compression), you are not alone.

More from Goldman on the Libya situation and what it means:

Brent surged to $105.74/bbl on Monday February 21, its highest closing price since September 2008, as political unrest in North Africa and the Middle East spreads, increasing physical risks to oil supplies

Brent crude oil prices surged to their highest levels since the financial crisis as the mass political protests which have arisen across the Middle East and North Africa region (MENA) in recent weeks spread to OPEC-member Libya and were met with violence. While earlier protests toppled governments in Tunisia and Egypt, prompting fears of political contagion and instability in more prominent oil and gas producers in the region, especially the Gulf Cooperation Council (GCC) countries, the protests in Libya are the first to meaningfully put oil supplies at risk. When we first published on these events three weeks ago, such political contagion seemed relatively unlikely, as the GCC countries are more affluent and generally have more stable and popular governments, and the main physical risks to the oil markets from the protests were more logistical in nature, centered on the potential disruptions of shipments through the Suez Canal and SUMED pipeline between the Red Sea and the Mediterranean (see our January 31, 2011 Commodities Update: Contagion risk moves markets, but physical risks remain low).

Since then, however, the wave of unrest has continued to spread across the MENA region. Protests in Libya have gradually intensified in recent days and have now reached the capital of Tripoli, while the second city of Benghazi is reported to be out of the control of forces loyal to the government. Libya is a member of OPEC and we expect its crude production to reach 1.6 million b/d in 2011, or 1.8% of global supply. So far, 100,000 b/d – roughly 6% of Libyan production – has been halted as a result of the unrest. In addition, violent clashes between protesters and government forces in Bahrain have shown that the richer Gulf states are not immune to these developments. The sectarian fault line dividing the ruling Sunni royal family and the largely Shiite protesters is likely also a major source of concern for the rulers of neighboring Saudi Arabia, which itself has a large Shiite population in its oil-rich eastern parts.

Clearly, these recent developments in Libya and Bahrain increase the risks of major supply disruptions, prompting Brent to rise $3.22/bbl and WTI to rise over $6.00/bbl on electronic trading as the market was closed for the Presidents’ Day holiday in the United States. The sharp move in WTI was all the more noticeable as the WTI market has been increasingly dislocated from the world oil market in recent weeks, with the WTI-Brent spread having collapsed to as low as -$16/bbl. Should Libya’s production be lost to the market, it would require more than half of OPEC’s spare capacity to offset the loss, pulling forward the return to a structural bull market in oil that we saw occurring in 2011H2 and 2012. After Monday’s (February 21) price rise, Brent prices are now at our 12-month target.

However, while the recent events represent a clear upside risk to our price forecasts, it is important to emphasize that even as the political situation in Libya becomes increasingly uncertain, it is not necessarily the case that oil supplies would be meaningfully disrupted over an extended time period. History has shown that oil can still flow even under very adverse political conditions, and an important point to watch is if the oil workers join the protests. Unfortunately, even if a substantial near-term disruption is avoided, the recent events may still have a lasting impact on supplies by discouraging oil investment and/or substantially raising the cost of investment via sharp increases in regional funding costs.

Below is a table of Goldman's existing prefered trades:

And the hedge fund's price target forecasts:

For everyone else who wishes to read Goldman's take on the Brent-WTI spread, and why they may be right this time around, the full report is presented below.



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