Oil prices have given up some of the gains achieved since the OPEC deal was agreed to in late November, and confidence in the buoyancy of crude prices is starting to falter. There are plenty of reasons why: U.S. shale is coming back; OPEC cuts led to higher prices in December, but have had little effect since then; crude and refined product inventories are still extraordinarily high; and speculative bets are looking overly optimistic at this point.
But the major investment banks tracking oil markets are surprisingly steadfast in their predictions that the market is proceeding steadily towards balance, albeit at a slow pace. A roundup of the latest research notes from Wall Street banks show little fear of a major downslide in prices. Bloomberg points out that Goldman Sachs, Morgan Stanley, Bank of America and Citigroup are all sticking to their predictions of moderate price gains this year.
“The outlook is no less bullish,” said Seth Kleinman, global head of energy strategy at Citigroup, while reiterating his call for oil prices to rise above $60 a barrel later this year. “Bringing oil inventories down is a messy process, but the OPEC cuts are real, demand in Asia is decent and ultimately the market is tightening.”
That is a totally reasonable position, but one major uncertainty cropped up this week with news that Saudi Arabia appears to have actually increased production in February, raising questions about its commitment and belief in the coordinated production cuts.
Goldman Sachs was unfazed by this news, citing Saudi assurances that the uptick in output was diverted into storage, and in any event, it would “be consistent with higher refinery runs locally in February.” As a result, the investment bank stuck to its belief that “the oil market rebalancing is still progressing, with continued evidence of strong demand over the past weeks comforting us in our forecast that oil demand is finally set to overtake supply in 2Q2017, helped by the cuts and despite the expected rise in U.S. shale output.”
That echoed a prior report from Goldman Sachs that said that the recent fall in oil prices makes bullish bets much more appetizing. “[W]e believe with oil at $48/bbl…the risk-reward supports re-entering these markets from the long side now if not invested or staying long if already invested as we are in our top trade recommendation,” Goldman analysts advised investors. So sub-$50 oil looks cheap.
Citi agrees. “Citi views this sell-off as a buying opportunity for 2017,” analysts from the investment bank wrote in a recent note.
But the banks diverged on what happens next with OPEC. First, Citi thinks that Saudi Arabia will do what is necessary to prevent oil prices from falling again, and that means extending the deal for another six months. “The oil markets are always noisy, but it looks like the Saudis are sending a clear signal that the kingdom will defend prices over market share for the remainder of this year,” Citi analysts wrote.
However, Goldman Sachs disagrees, cautioning against assuming the OPEC deal will be rolled over for the rest of 2017. Moreover, the investment bank said that it wouldn’t even be in OPEC’s interest to do so because the goal of coordinated production cuts is to “normalize inventories, not support prices.” Then, Goldman analysts offered a sobering prediction: “As a result, our base case remains that the production cuts will be followed by new production highs.”
If Goldman is correct, the implications for oil prices are enormous. If Saudi Arabia returns to higher production levels in order to regain market share, crude will be moving well below $50 per barrel for quite a while.
The Wall Street Journal offered some insight into this possibility, reporting on March 16 that Saudi Arabia’s energy minister Khalid al-Falih is “fed up” with several OPEC members not living up to their production cuts pledges. Al-Falih reportedly spoke to his Russian and Iraqi counterparts in Houston on the sidelines of the CERAWeek Conference last week, where he was visibly frustrated as he implored them to cut their output. The WSJ reported that sources familiar with the matter say that Saudi officials cannot “support the output cuts for long without help,” as low oil prices combined with a cutback in output are hurting state finances.
To sum up, we have a growing pile of evidence suggesting that Riyadh is in the midst of a rethink about what to do next: Saudi Arabia is “fed up” with its OPEC peers; al-Falih warned the oil markets last week that Saudi Arabia would not “bear the burden of free riders”; and on top of that, Saudi Arabia reversed its cuts in February, boosting production by 263,000 bpd. Saudi officials are sending clear signals that an extension of the OPEC deal should not be assumed.
Wall Street investment banks might be forced to revisit their bullish predictions for crude oil for the second half of 2017.
By Nick Cunningham of Oilprice.com
