Oil prices face uphill climb in quest to achieve balance

A ramp-up in shale drilling and production rebound in Nigeria and Libya, weakens prospects for normalization in inventories ahead of OPEC cuts scheduled to end March 2018, says analysts at Goldman Sachs.

It is expected that this will leave prices trading near $45/bbl until there is evidence of: a decline in the US horizontal oil rig count, sustained stock draws or additional OPEC production cuts, said a note by Goldman Sachs’ analysts led by Damien Courvalin, obtained by BusinessDay June 29.

The analysts believe that given that the market is now out of patience for large stock draws and increasingly concerned about next year’s balances, price upside will need to be front-end driven, coming from observable near-term physical tightness.

Oil prices have struggled to find the floor after rising to over $50per barrel a month ago, but the analysts believe that cyclically, the balance of risks is nonetheless shifting from the downside to the upside.

Factors responsible include that “global inventories are still drawing and we continue to forecast a deficit this year, net long positioning is back to its February 2016 low level, and production disruptions are at their lowest levels in 5 years and skewed to the upside.

Others are  that OPEC should act and cut more than what Libya/Nigeria are adding, demand forecast remains above consensus expectations, and it is yet to be seen if the US service sector can convert this unprecedented increase in drilling into production and what inflationary pressures this will create.

As a result, Goldman Sachs said it is lowering its 3-month WTI forecast to $47.50/bbl from $55/bbl previously, but it remains above the forward curve.

The analysts further said that structurally, ongoing productivity gains for shale and cost deflation elsewhere corroborate their $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.

“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,” says Goldman Sachs.

The expectations for a gradual increase in prices driven by near-dated timespreads is tempered by the a surge in price rally in the short-term, likely driven by short covering, would allow US producers to hedge, helping insulate their 2018 drilling from a sequential decline in prices and likely setting the stage for a greater pull-back later this year.

“Secondly, should the pace of draws fall short of our expectations, we believe the oil rebalancing could become the muddle through we had first feared in March 2016. This would leave oil prices stuck near $45/bbl and in a mild contango, with gradual OPEC growth/cheating offsetting a gradual slowdown of shale production growth,” says Goldman Sachs analysts.

ISAAC ANYAOGU