Goldman Sachs: Oil Drop Not a One-Off Event

A recent Exchange at Goldman Sachs podcast presented the views of the company’s global head of Commodities Research, Jeff Currie, who has a new report out called The Revenge of the New Oil Order.

In light of recent market turmoil and the price war for crude oil between OPEC and Russia, Currie stated that “ . . . this price war really is a second-round effect of the coronavirus. In terms of what this did to our price forecast, it took what at the beginning of the year was a 63-dollar-a-barrel price forecast on Brent, the coronavirus took it down to $45 a barrel. The price war has now taken it from 45 down to $30 a barrel at least over the next six months.”

Currie also believes that there are three reasons for the emerging oil price war: “The first is that when you look at the balance sheets of the U.S. producers, they had already been damaged substantially by the decline in prices due to the coronavirus. That’s my point that this is really a second-round effect of the coronavirus itself. So acting today, it’s much easier to tip the balances of these companies than it would be otherwise. The second reason has to do with the fact that U.S. sanctions have had a substantial impact on Russia, particularly on the gas side. You’ve had the Nord Stream sanctions. You have also had sanctions on Rosneft, and on gas, again, second-round effects of the coronavirus. You’ve seen that gas demand in China was down 40 percent, at least the imports of LNG. Those LNG exports from places like the U.S. were going into the European market where there was still a premium. When we think about the impact that this has had on Russian gas prices, it has been substantial. Then the third reason, again why today, Saudi imposed an ultimatum on Russia, and Russia typically does not like those kind of outcomes, and so that’s why we tend to think that, hey, this is the beginning of a price war. I really don’t like the word ‘price war.’ I like to really call it a market share strategy.”

Currie stated that in spite of some rebounds in the overall market, “it’s too early to get long on a sustainable basis, at least the commodity . . . but yes to the energy equities.”

Curries believes these new developments shift the market’s focus “back to the new oil order.”

He states, “The new oil order which we introduced in 2014 was really predicated on the idea that low-cost producers have an economic incentive to increase production to gain market share. The reason for this is the fast-cycle nature of shale that can expand production rather quickly and take market share away from the OPEC countries.”

He adds that in this environment, production cuts are not economically beneficial and that when OPEC cut production, those who ultimately paid the price were shareholders of the energy equities. He adds, “So the new oil order is predicated on this idea that, hey, the low-cost producers should be pursuing a strategy of market share.”

Currie says this has led to new Goldman Sachs forecasts that are “now $30 a barrel on a Brent basis for 2Q and 3Q of this year. Then beginning in fourth quarter, we now expect to see a steady upward march in prices; 40 in the fourth quarter going to 45, 50, 55 and then ultimately $55 a barrel in the fourth quarter of next year. That represents a normalization in the market that we saw at the beginning of this year. I think third in terms of thinking about what does this do to the fundamental outlook, we see inventory builds occurring in the second and third quarters of this year.”

Based on estimates of Saudi production and the overall markets, Currie expects a fourth quarter price increase will be driven declining inventories. He states that there are three distinct phases that we have identified during these price war-type dynamics. The first is a survival phase. The second is the inflection phase, and the third is the regeneration phase.”

Currie says that the current situation is more dire than in previous price wars. He says, “When we think about what Saudi’s doing here from a pricing dynamic, meaning slashing the official sales prices, it’s more akin to what happened in 1986 which, by the way, ironically it was what ultimately helped lead to the fall of the Soviet Union . . .”

After looking back at the 2014 oil price decline, Currie asks, “When we think about what Saudi’s doing here from a pricing dynamic, meaning slashing the official sales prices, it’s more akin to what happened in 1986 which, by the way, ironically it was what ultimately helped lead to the fall of the Soviet Union . . .”

Currie adds, “So when we think about the current environment, the question really is, are we going to finally see that phase three, that regeneration and restructuring of the industry that should have happened five years ago and could potentially happen over the next several years? Our base case is that this lasts through the summer months. However, if we look at this morning, Saudi Arabia came out and announced production to be increased to 12.3 million barrels per day. We view that as more saber-rattling. It would be difficult for them to achieve those kind of numbers which would be an indication they’re threatening Russia to try to get a quick settlement. However, when you saw the Russian Energy Minister Alexander Novak’s response to that, he was talking about seeing an OPEC meeting in May or June of this year.”

Currie cautions that “It’s important to note that an agreement is not necessarily bullish. They could come to an agreement of quotas that are at higher levels, extending a market share strategy but formalizing it under an OPEC+ agreement. So when we’re talking about agreement, it’s not necessarily bullish. It could just be a continuation of the current strategy.”

Asked if this is a one-off event, Currie stated that it is more likely “structural.” He explained, “We’re going back to problems that were apparent in ’15 and ’16 that were cut short by stimulus and OPEC production cuts, and we’re now back in an environment which we’re creating that rebalancing. Yes, the coronavirus helped be able to accelerate this process through lower demand and lower prices. In a price war, it’s much easier to accomplish it today than it would have been at a much higher demand environment, but I think the key here is that ultimately this rebalancing is inevitable, and we need to go through it.”

Asked what he worries about going forward, Currie cited the public’s dissatisfaction with the political response to coronavirus pandemic, particularly in places like Italy. 
To listen to the entire podcast, click here.