‘We Highly Recommend Not Riding This One Out’: As Oil Passes $80, Goldman Reiterates Commodities Case

Good news for Riyadh: Brent hit $80 on Thursday for the first time since 2014, which puts prices in line with what some in the Kingdom have reportedly been aiming at.


This of course comes amid more sanctions on Iran and an increasingly aggressive approach towards Hezbollah, with Treasury blacklisting Hassan Nasrallah on Wednesday a day after sanctioning Iran’s central bank governor.

Although John Bolton’s “Libya model” comments are likely to end up getting him sidelined in negotiations with North Korea the same way Peter Navarro has reportedly had his hand slapped in trade negotiations with China for insisting on pushing the most hawkish message possible, Bolton’s mere presence in the administration is enough to embed a significant geopolitical risk premium in crude.

Meanwhile, Goldman was out on Wednesday evening with a new note reinforcing the case for commodities, a case which the bank has been making very (very) hard of late.

First, Goldman suggests specs are getting cold feet at the wrong time and the bank is busting out the exclamation points in case you’re in anyway unclear what their thesis is. To wit, form the note mentioned above:

Best performing asset class now posts the best ytd returns in a decade (+10%) as oil nears our $82.50/bbl target, surpassing the returns of 2011 when the Arab Spring created a supply shock in Libya. Unlike then, however, this continues to be a demand led late-cycle rally as supply disruptions remain modest by comparison even in hot spots like Venezuela. And this current rally likely has room to run, particularly from a returns perspective, as the current fundamental backdrop for oil is now more bullish than we had expected as strong demand now faces supply disappointments (see Exhibit 1). As a result, we are raising our 12-month S&P GSCI returns forecast to 8% from 5%. Surprisingly, markets remain complacent. Oil speculative net long positions have been declining since $73/bbl with the common manta, ‘we will ride this one out’. These are dangerous words from a risk management perspective. Financial markets’ focus on slowing global growth rates and rising US rates matter far less for physical markets, which is why only gold has traded substantially lower with the risk-off driven dollar strength. Growth concerns will likely prove temporary, realized demand remains robust and OPEC has never been able to catch late-cycle demand growth to replenish inventories before a recession occurs. And even if growth were to decelerate sharply, it would take global GDP growth collapsing to 2.5% yoy to simply balance the oil market! As a result, we highly recommend not ‘riding this one out.’


This comes on the heels of BofAML raising the prospect of $100 oil, becoming the first Wall Street firm to do so last week. Here was their rationale, for anyone who missed it:

Looking into the next 18 months, we expect global oil supply and demand balances to tighten driven by the ongoing collapse in Venezuelan output. In addition, there are downside risks to Iranian crude oil exports. Plus we see a high likelihood of OPEC working with Russia in 2019 to set a floor on oil prices. As a result, we project an oil market deficit of 630k b/d in 2018 and 300k b/d in 2019. The deficits should push OECD oil stocks down closer to 2.6bn barrels by 4Q2019. With inventories set to drop below 5-year normals, we raise our average Brent forecast for this year and next to $70/bbl and $75/bbl respectively. We also introduce a 2Q $90/bbl Brent price target for 2019 and see a risk of $100/bbl oil next year, although we are concerned that these market dynamics could unfold over a shorter timeframe.

You might recall our assessment of the notion that Saudi Arabia is going to be willing to step in and replace lost Iranian barrels. Long story short, you can count us incredulous. To wit, from a post over at Dealbreaker:

While the Saudis support Trump’s decision on Iran, they’re also pretty keen on seeing higher prices in the interest of driving up the valuation on Aramco and also for other reasons tied to the Kingdom’s fiscal position and financing the ongoing (and seemingly intractable) conflict with the Houthis in Yemen (bombs ain’t cheap, yo!)

And because there’s only so much money you can extort from your relatives on the way to replenishing your reserves, oil prices need to rise even if that entails otherwise uneconomic U.S. production comes back online or is further emboldened.

Given that, the assumption that Riyadh is going to be willing to step in and replace any lost Iranian barrels in the interest of keeping prices anchored seems a bit tenuous — no matter what the official word from the Kingdom is.

For their part, Goldman (partially) agrees and they also note the obvious, which is that the market’s capacity (figuratively and literally) to absorb a supply shock is limited by Venezuela’s “progress” towards becoming a failed state. Here’s the bank again, from the same note cited above:

US shale cannot solve the current oil supply problems. With respect to Iran, we believe the withdrawal of the US from the JCPOA may put a few hundred thousand barrels of Iran exports at risk by year-end. While US allies such as Saudi Arabia will likely respond, they are unlikely to proactively replace these barrels, especially given their current narrative that the oil market is not fully rebalanced. Further, their response will reduce spare capacity in an increasingly tighter market. Beyond core-OPEC, the erosion in Venezuelan and Angolan oil output is accelerating at the same time the big engines of ex-US supply growth such as Brazil are also beginning to disappoint (see Exhibit 1). Only the US has seen significant upside surprises in production owing to the high prices, but shale is facing growing pains as faster growth has filled available pipeline capacity faster than expected.

So you know, make of all that what you will, but I guess what we would say for the umpteenth time is that you should consider it in the context of rising inflation expectations and the possibility that, if real rates in the U.S. have become at least partially a function of those inflation expectations by virtue of the market anticipating the Fed’s reaction function, well then you end right back in that self-feeding loop where breakevens follow crude higher and that stokes rate hike bets which in turn drive up real rates which in turn weigh on risk assets and around we go.


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