While we are not sure if the market has finally had time to actually read Goldman's oil note from Sunday night (posted here at the same time) and understand that far from bullish Goldman actually warned that the market rebalancing is taking far longer and as a result is lowering its 2017 price targets, there was one additional curious highlight in the report: Goldman's breakdown of critical prices bands for oil which actually is a useful guide for how the broader market (if devoid of momentum-chasing algo traders) would respond with oil trading in any given price interval .
- Below $30/bbl is the price range when inventories near storage capacity. This risk has passed in our view absent a sharp reversal in global growth.
- Below $40/bbl, producers respond by aggressively slashing spending and future production. This threshold was made explicit by the US credit agencies when they downgraded 15% of US E&Ps to high yield earlier this year. We no longer need to be in this range unless the systemic disruptions reverse (Nigeria, Libya) or low-cost producers surprise to the upside once again in 2016 or 2017.
- Between $40/bbl and $50/bbl is the muddle through. It’s the range (1) that most non-OPEC producers budgeted for 2016, and (2) where US producers on aggregate are not ramping up activity: some are focusing on drawing down their well backlog while the aggregate rig count continues to decline. This is where prices will remain through 2Q.
- Above $50/bbl is where activity will start to ramp up although operational frictions and levered balance sheets will slow this activity initially. This threshold has been explicitly stated during US earnings releases and is also consistent with the notable increase in hedging with calendar 2017 prices near $50/bbl. The ongoing open access to capital creates the risk that activity can ramp up meaningfully more near $50/bbl than we expect, with a US E&P raising equity this past week to ramp up its drilling activity. We also see risks that brownfield capex spending increases near this threshold, as producers seek to maximize returns and cash flow.
- Near $60/bbl is when new projects will be sanctioned and shale activity will accelerate, which we do not require until late in 2017 in our view.
And since Goldman is now assumed to be "bullish" (which it actually isn't), we are delighted to take the other side of the trade and expect a repeat of the summer of 2015 price action as we noted previously: peak prices for the next few months, then another sharp drop as supply shortages are eliminated and as a flood of new oil hits the market just in time for the Chinese credit-bust slowdown.