Earlier today, we got exactly what a lot of folks were expecting: a “sell the news” moment in crude following the OPEC meeting.
Although Saudi Oil Minister Khalid Al-Falih said the cartel considered 6, 9 and 12-month scenarios during Thursday’s meeting, they ultimately decided a 9-month extension was “optimal.”
For those who missed it, you can read the highlights here: OPEC Agrees To 9-Month Extension Of Cuts, Market Shrugs.
“Investors may have taken long positions ahead of OPEC meeting to protect against bigger-than-expected production cut, and positions may have been closed in the absence of such an announcement, adding to the pressure on oil prices,” ABN Amro senior oil economist Hans Van Cleef wrote in emailed comments to Bloomberg.
Iranian Oil Minister Bijan Zanganeh called Thursday’s price action “surprising” and “based on speculation, not fundamentals.”
Whatever. The question is simply this: “what now?”
Well, Goldman will tell you what now. Or at least they will try in that kind of way where “try” means fit today’s news with a generally upbeat take on the outlook for oil prices.
Here’s the bank’s reaction…
Buy the rumor, sell the news
The lack of (1) greater cuts, (2) potential caps on Libya/Nigeria, (3) a clear exit strategy beyond managing the 1Q18 seasonal build is driving prices lower, with Brent prices down $2/bbl so far. As we noted previously, we believe such a decline is not that surprising given (1) the shift in market focus from projected but uncertain future deficits to observable stock draws, (2) the poor Sharpe ratio of trading long-term fundamentals since last November’s OPEC meeting, (3) the disappointing pace of the draws and the fear that non-OECD draws, including among the producers supposed to reduce production, will further delay visible OECD stock draws, and (4) the concerns over the compliance of participants.
Given our forecast for inventory draws through 2Q and our expectations that OECD inventories can reach their 5-year average level by early-2018 through these cuts, our 2H17 Brent spot price forecast remains at $57/bbl. We expect this will be reached by rising near-dated prices, as stocks draw, with long-dated prices likely declining further as the forward curve rotates towards backwardation.
Expecting still relatively high compliance, although Libya/Nigeria ramping up. Specifically, we believe that fundamentals are improving, with decent draws in the recent weekly stock data, and our projected 2Q17 OECD draws of 385 kb/d. Since today’s announcement came in line with the assumptions we had made in our latest oil supply-demand balance update, we reiterate our forecast that OECD inventories will normalize by early 2018. This forecast is based on our assumption that OPEC compliance by the members under quotas will remain high at 93% in 2H17 but will start to decline to reach 83% in 1Q18. Further, we expect Libya and Nigeria production to average 750 kb/d and 1.75 mb/d, respectively, with the former now nearing 800 kb/d and the latter helped by the return of the 250 kb/d Forcados pipeline in June. A larger recovery would slow the draw in inventories and require either a deeper cut or a further extension before OECD inventories reach their 5-year average levels, which seems likely given the continued commitment of participants to normalize inventories.
Backwardation is the solution. We, however, see risks for a renewed surplus later next year if OPEC and Russia’s production rises to their expanded capacity and shale grows at an unbridled rate. How can OPEC avoid this boom-bust cycle and achieve both fiscal stability and rising revenue through oil market share gains? As we argued earlier this week, the binding force to sustainably slow shale growth lies on the funding side and we believe that sustained backwardation can restrain access to the large pools of private equity and HY credit capital.