"How Did It Go So Wrong" Goldman Asks, As It Slashes Oil Price Target

""Spot WTI oil prices at $43/bbl are now back to November pre-OPEC deal levels, down from $52/bbl just a month ago and vs. our prior 3-mo $55/bbl forecast. How did it go so wrong?

       - Goldman Sachs

Goldman has done it again.

Shortly after Goldman's tech analyst came out with a bullish note on WTI, saying oil is now "shifting focus back onto ~51.67-51.81. Keeping a stop at 43.32 (Jun. 22nd high)...." and adding "daily oscillators are crossing upwards from the bottom of this recent range... this ultimately opens up potential to eventually re-test the 200-dma/Dec. ’16 downtrend up at 51.67-51.81. Reaching these pivots would still maintain the trend of lower/lows and lower highs that has been in place since January...."

... Goldman's commodity analyst, Damien Courvalin came out and in a note which contains the infamous words "How did it go so wrong",  cut Goldman's 3 month price target on WTI from $55.50 to $47.50 as "shale drilling ramp-up and large rebounds by Libya, Nigeria are expected to slow 2017 stock draws" crushing Goldman's man near-term bullish thesis.  Courvalin also notes that prices will trade near $45/bbl until U.S. horizontal rig count lowers, stock draws increase or OPEC makes additional output cuts  Goldman's suggestion is that to normalize inventories, OPEC should cut more than what Libya, Nigeria adding.

"We have yet to see if the U.S., service sector can convert this unprecedented increase in drilling into production"

And while Goldman cut its near -term price target, it keeps its long-term WTI price “anchor” at $50/bbl on ongoing shale productivity gains and cost deflation elsewhere. At least until that too is cut in the not too distant future.

Here are the key sections from Courvalin's note:

Spot WTI oil prices at $43/bbl are now back to November pre-OPEC deal levels, down from $52/bbl just a month ago and vs. our prior 3-mo $55/bbl forecast. How did it go so wrong? The surprise over the past month was that two large US stock builds and the unexpected ramp-up in Libya and Nigeria reduced the confidence that inventories would normalize before the end of the OPEC deal. Concurrently, the steady increase in the US rig count and the six month drilling to production lag now imply that US production will be growing strongly by the end of the OPEC deal. This threatens to close the window of time for stocks to normalize before the OPEC cuts end and raises the concerns that OPEC will then ramp up production to defend market share. 

 

No longer being able to dissociate between the 2017 draws and the concerns of a surplus in 2018, Dec-17 oil prices could no longer act as the anchor and pivot for the forward curve and left the whole curve to return into contango. In fact, trading of the distinct 2017 vs. 2018 balances through long Dec-17 vs. short Dec-18 timespread positions likely precipitated this unraveling by offering producers too strong a price signal to ramp-up production this year.

 

 

Despite the market losing its pivot point, the other relative moves in oil prices during the recent sell-off have remained consistent with our fundamental framework:

 

The threats of a surplus next year precipitated the decline of the 1-n year forward price to $45/bbl, which we discussed last month had to occur (albeit in our view only gradually), to slow the shale rebound

The still ongoing draws have driven near-dated timespreads stronger over the past month, with no visible impact yet of the Libya/Nigeria recovery

 

 

The new anchor is likely to be the price at which shale activity slows

 

The oil market is back to searching for an anchor and we believe that this will likely be for now the price at which shale activity slows. Until a month ago, the greater than seasonal March-May draws and the upcoming May OPEC meeting had helped rationalize the steady ramp up in US activity. Data since then has however shaken confidence that these draws were real and sustainable and the market must now address the shale response. Shale’s velocity is making it the marginal barrel today, pushing the burden of proof on determining once again at what price oil horizontal drilling activity will decline.

 

Where does this leave us? We believe that prices have reached a level near $45/bbl at which US producers should start to adjust their drilling activity. Further, strengthening near-dated timespreads suggest that the draws we expect have yet to unravel. The threat of Libya/Nigeria production, the uncertainty on when and at what price level shale activity will slow and the shrinking window of time for the draws to normalize inventories before OPEC is tempted to ramp up all leave us cautious of calling for a sharp bounce in prices here.

And the summary:

  • The fast ramp-up in shale drilling and the unexpectedly n large rebound in Libya/Nigeria production are on track to slow the 2017 stock draws. This creates risks that the normalization in inventories will not be achieved by the time the OPEC cut ends next March. We expect this will leave prices trading near $45/bbl until there is evidence of (1) a decline in the US horizontal oil rig count, (2) sustained stock draws or (3) additional OPEC production cuts. Given that the market is now out of patience for large stock draws and increasingly concerned about next year’s balances, we believe that price upside will need to be front-end driven, coming from observable near-term physical tightness.
  • Cyclically, we believe that the balance of risks is nonetheless shifting from the downside to the upside: (1) global inventories are still drawing and we continue to forecast a deficit this year, (2) net long positioning is back to its February 2016 low level, (3) production disruptions are at their lowest levels in 5 years and skewed to the upside, (4) OPEC can (and in our view should) act and cut more than what Libya/Nigeria are adding, (5) our demand forecast remains above consensus expectations, and finally (6) we have yet to see if the US service sector can convert this unprecedented increase in drilling into production and what inflationary pressures this will create. As a result, while we are lowering our 3-mo WTI forecast to $47.50/bbl from $55/bbl previously, it remains above the forward curve.
  • Structurally, however, ongoing productivity gains for shale and cost deflation elsewhere corroborate our $50/bbl long-term WTI price anchor. While this leaves risk to our 2018-19 $55/bbl forecast squarely skewed to the downside, the shale breakeven discovery process is still a work in progress given the opposing forces of productivity gains, cost inflation and the dynamic cost structure of shale.

And the punchline of the whole report:

This leaves us cyclically bullish within a structurally bearish framework: the near-term price risks are now increasingly skewed to the upside while the low velocity deflationary forces of the New Oil Order are still at play.

Good luck figuring out what that means.