While large shifts in positioning precipitated a sell-off in oil prices that far exceeded the actual weakening in fundamentals, Goldman Sachs' confidence in a 2015 oversupplied global oil market has increased. As a result, they have brought forward their medium-term bearish oil outlook (WTI crude oil forecast is $75/bbl for 1Q15 and 2H15 (from $90/bbl previously)). WTI just broke below $80 back to June 2012 levels once again as Goldman also downgraded the entire oil service space (happily buying up muppets' positions as they sell).
As Goldman Sachs notes,
While oil inventories had remained stable since mid-2012 on the offsetting forces of: (1) strong US shale oil production growth, (2) rising OPEC supply disruptions, and (3) modest demand growth, 2014 has seen this precarious equilibrium unravel with: (1) continued strong US production growth against expectations for a slowdown, (2) OPEC disruptions easing with Libya, Iran and Nigeria increasing production, (3) a slowdown in global economic growth and oil demand in 2Q14. These shifts led to a large year-to-date build in OECD petroleum, the largest since 2006. While this sequential build in OECD total petroleum inventories has helped offset the deficit observed in 2H13, inventory levels remain below their 5-year averages, even when factoring in the IEA’s preliminary counterseasonal September build in inventories. Importantly though, we now believe that the dynamics behind this rise in inventories are sustainable and will lead to a significant further build in inventories in 2015.
On the supply side, we believe that: (1) non-OPEC production growth outside of North America is set to accelerate on continued growth in offshore production, (2) prior to recent declines in prices, US Lower 48 oil and NGL production was on track to sustain production growth near 1.0 mb/d in 2015, and (3) core-OPEC will not cut production significantly in coming months. On the demand side, while we believe that one-off factors have exacerbated the weakness in 2014 oil demand growth, the acceleration in demand that we expect in 2015, even under lower prices, is not sufficient to offset the strength in supply.
As a result, prior to assuming our lower price forecast (and its impact on US shale production), we estimate that the global market oil imbalance would have reached 1.0 mb/d in 2015 in the absence of additional disruptions. Consequently, we lower our oil price forecast to a level that we believe will achieve a slowdown in US shale oil production. Once a slowdown in US shale oil production growth is apparent, we expect that a lagged reduction in OPEC production will limit the global oil market surplus to 1H15 with inventories stabilizing in 2H15 and 2016.
Oil prices will need to decline to slow US shale
We are lowering our oil price forecast to reflect the required slowdown in US production growth: our WTI crude oil forecast is $75/bbl for 1Q15 and 2H15 (from $90/bbl previously). Given our unchanged WTI-Brent spread forecast of $10/bbl, our Brent forecast is now $85/bbl ($100/bbl previously). Our forecast path reflects our expectation that timespreads will be weakest in 2Q15 when the global oversupply will be largest with Brent prices reaching $80/bbl and WTI prices $70/bbl. In 2016 we expect stabilizing fundamentals with moderate cuts to OPEC production once a slowdown in US production growth is apparent. Our 2016 and long-term forecasts are now $80/bbl WTI, $90/bbl Brent. Uncertainty around the required price to slow down US shale production growth is a key risk to our price forecast.
OPEC loses pricing power, shale shifts to the margin
A tight global oil market had until now required strong OPEC production and US shale production growth. While getting to a point where the market shifted back into surplus was only a matter of time, as US shale oil production grows by Libya’s capacity every year, we now have higher confidence that a structural transition has been reached and that US production growth needs to slow. Accordingly, our forecast also reflects the realization of a loss of pricing power by core-OPEC. Consistent with the economics of the “dominant firm/competitive fringe” market structure and shale production exceeding OPEC spare capacity, pricing dynamics in the oil market have moved away from the dominant firm’s production decision and towards the marginal cost of US shale oil production.