After trading in the mid-80s for much of the past two months...
... oil prices cracked today, and fell sharply with Brent sliding below $79/bbl, weighed down by concerns over the current COVID wave in Europe and the potential return of lockdowns. In response Goldman, which has been extremely bullish on oil prices of late, said that just like with the SPR headlines on Wednesday, "we estimate that this move lower has far overshot the actual fundamental risks due to low trading volumes."
Specifically, Goldman says that its pricing model shows that the $8/bbl price decline since late October is equivalent to the market pricing in 4 mb/d combined hit to demand or increase in supply over the next three months. This, as the bank indicates, would be for example equivalent to a 100 mb government stock release as well as a 1.75 mb/d hit to demand due to the current COVID resurgence. Putting such a move in context, this would be double the size of the strategic stock release considered according to Reuters (which, if implemented in swaps, would be even smaller), as well as a global COVID impact that would be c.1.5 times that of last winter, when vaccination rates were extremely low (and with the current stock of DM hospitalizations at a third of its level this time last year).
To be sure, there are also concerns over Chinese growth and its property sector, which as Goldman's Damien Courvalin writes, have likely contributed to the move lower as well but, there again, the commodity strategist believes that "the oil market has overshot" for several reasons:
- First, while Goldman's high-frequency tracker of Chinese oil demand does show demand sequentially declining in recent weeks, it remains up year-on-year.
- Second, assuming a 70 mb SPR release and a hit to global oil demand outside of China similar to last winter's at c.1 mb/d, and no OPEC response - all still aggressive assumptions - the oil move lower would represent an additional 1 mb/d hit to Chinese oil demand from current levels over the next three months. This would be equivalent to assuming the same lockdown impact as this summer (0.5 mb/d over three months) as well as a 5% hit to Chinese GDP for one quarter using standard income elasticities, well beyond what our economists expect.
On net, Courvalin finds that low liquidity has left the oil market pricing in the trifecta of a record large SPR stock release, aggressive lockdowns in Europe and a sharp slowdown in Chinese growth.
He therefore views "the move as excessive", especially as the oil market remains in a large deficit, and reiterates his $85/bbl 4Q21 average forecast.
High-frequency inventory data points to a current supply-demand imbalance of c.2 mb/d over the last 4 weeks, with OECD crude and Atlantic basin product inventory at 7-year lows. This magnitude of deficit is in fact on its own sufficient to absorb the current perceived headwinds to the oil bull thesis, with lower prices in fact reducing the odds of a strategic release.
Meanwhile, the move lower has lead to a sharp flattening of the oil forward curve, with time-spreads selling-off sharply. As a reminder, Goldman's preference is to be positioned long in deferred futures to trade the structural re-pricing higher of oil prices (our Dec-22 and Dec-23 trades). The high valuations of timespreads had led the bank to close its Dec-21 vs. Dec-22 timespreads late October given the poor risk-reward of timespread positions at such levels. However, the bank now believes that the flattening in timespreads has also overshot and now recommends entering a Dec-22 vs. Dec-23 Brent timespread position at c. $3.4/bbl.