It has been a rollercoaster session for oil which initially tumbled into today's OPEC+ session on the naive belief that Saudi Arabia and Russia would actually comply with Biden's demands to pump more (they did not), and then after reversing losses, it was hammered again only not due to supply fears but over positioning ahead of the BCOM/GSCI roll that starts on Friday, futures brokers said cited by Bloomberg. Unconfirmed reports of a 1 million bpd increase of crude at Cushing according to Wood Mackenzie did not help sentiment.
So is today's reversal a warning from the market that we have seen the local highs? Not according to Goldman, because on Thursday afternoon, the bank's commodity analyst Damien Courvalin wrote that his "bullish view remains unchanged: the oil deﬁcit remains unresolved, the current strength in oil demand remains a near-term tailwind and the increasingly structural nature of the deﬁcits will require much higher long-dated oil prices"
First, some background from Courvalin on what took place during today's OPEC+ meeting: OPEC+ agreed to maintain its gradual production increase of 400 kb/d for the month of December despite pressure from oil importing countries to ramp-up faster. Three stated reasons during today’s press conference:
- concerns over oil demand in the short-term on the potential for a winter COVID wave, as seen currently in China, as well as seasonal year-end demand weakness,
- an expected weak oil market next year, with the OPEC Secretariat forecasting a large surplus,
- the already agreed upon plan to ramp-up production further in coming months and the potential to ramp-up more aggressively quickly given the monthly frequency of OPEC meetings.
Here, Goldman sees three additional catalysts.
- First, the unanimous nature of OPEC’s decision makes a faster ramp-up difﬁcult to agree to, especially as half of OPEC+ members are unable to meet their quotas. This includes Russia who, as the second pillar of the deal, would likely oppose a unilateral increase by Saudi Arabia.
- Second, the slow supply response of shale producers has brought the group its pricing power back, leaving a slow ramp-up in output ﬁscally more beneﬁcial than higher volumes.
- Third, oil prices are ultimately not elevated, especially when factoring in wealth effects –our estimate of oil consumer spending per GDP (based on retail prices covering 98% of global demand) shows that current prices are only in their 63rd percentile since 2000.
While the openness to potentially produce more later stated at the press conference (where members were called to speak and state their commitment to oil market stability) could assuage for now the demands of the US and other oil importing countries, there is a risk, however, that these countries nonetheless respond by releasing oil from their strategic reserves to help cool prices (which may not be a coordinated IEA emergency release as there has been no “sudden and signiﬁcant supply disruption”).
However, as Goldman has argued previously (see "SPR Sale Would Release Only 60MM Barrels; Will Bring Even Higher Oil Prices: Goldman") an SPR release would only be of modest and temporary help and could in fact backﬁre next year given the structural nature of the oil market deﬁcits starting in 2023.
- First, a 60 million barrel US SPR release would only represent $3/bbl downside risk to the bank's price $90/bbl year-end Brent forecast.
- Second, any larger negative price impact that further slows the US shale oil activity rebound would in turn lead to much higher prices next year.
- Finally, an SPR release now would likely be premature in our view given that the US mid-term elections (which have been cited by the US administration as a catalyst to push prices lower) are still a year away.
Net, Goldman's bullish view "remains unchanged" for three reasons:
- First, the oil deﬁcit remains unresolved and requires higher oil prices.
- Second, the current strength in oil demand remains a near-term tailwind as it is coming above consensus expectations (with OPEC’s demand assessment especially low in our view).
- Third, the increasingly structural nature of the deﬁcits will shift next year the bullish impulse to supply, requiring much higher long-dated prices. As for a larger increase in OPEC+ production at its next meeting on December 2, it may well be warranted with the strength in demand, bringing the global deﬁcit to 2.5 mb/d last month, 0.8 mb/d larger than the bank had expected.
Still, the now open disagreement between OPEC and the US administration and the threat of an SPR release - which according to some is behind today's oil price weakness - will nonetheless increase the volatility in oil prices, as evidenced already this week in particular for WTI timespreads. This volatility may be further exacerbated by headlines around the resumption of negotiations with Iran, tentatively scheduled for late November, as well as winter weather which could swing oil demand by 1 mb/d and with trading liquidity further set to fall into year-end.
As Courvalin concludes, "this leaves our long Dec-22 trade recommendation our favored bullish oil trade, offering in our view the best return vs. volatility trade off as perceived near-term bearish risks (COVID, OPEC, Iran, US SPR) would only further delay the required ramp-up in investment and exacerbate the structural deﬁcits that we forecast starting in 2023."