Oil prices soared in recent days, with Brent rising to its highest point since early November. The tightness in the market is real, but prices may not increase a whole lot more from here.
“We don’t think you’re going to get back to those $80 levels again, so you’ve got some modest upside here,” Goldman Sachs’ head of commodities research, Jeff Currie, told CNBC this week.
Currie and his team of analysts laid out a bullish narrative in an April 8 research note. “Brent prices have finally reached $70/bbl, following a fundamentally led rally reflective of a deficit larger than even we had forecast,” the Goldman analysts wrote. The OPEC+ production cuts were phased in quickly, a strategy Goldman dubbed “shock and awe.” In contrast, the group phased in cuts in 2017, which resulted in a protracted effort that only gradually reduced inventory levels.
Meanwhile, sanctions on Venezuela and Iran are knocking supply offline, and turmoil in Libya threatens to hit the oil market with another major outage.
Goldman Sachs was surprised by the speed with which the oil market tightened, and the investment bank hiked its forecast for average Brent prices in the second quarter to $72.50 per barrel, up from $65 previously.
But even as Brent has rallied more than 30 percent since the start of the year, Goldman analysts think that the rally has largely run its course.
“While the macro risk-on environment and the threat of disruptions may drive spot prices even higher, we still expect that prices will decline gradually from this summer as shale and OPEC production increases,” they concluded. “With large spare capacity in OPEC and the Permian basin and a wave of long-cycle projects still expected to come online in 2020, we maintain our $60/bbl forecast for next year.”
The cautious tone is notable given that Goldman analysts do not see any cracks in demand. When CNBC asked Goldman’s Jeff Currie about the possibility of a slowdown in consumption, he rejected the notion. “No — absolutely the opposite. Commodities demand is relatively rock solid, demand is so solid in China right now ... Bottom line, demand looks really good right now,” he said.
The reason that the investment bank does not see oil prices shooting up to $80 is because OPEC+ would be under pressure to begin to unwind the production cuts, while U.S. shale would also kick into a higher gear. If longer-dated oil prices begin to rise, it could stimulate new drilling in the Permian. That could push down prices next year. The flip side is that if production seems to be climbing this year, it would weigh on longer-dated prices, which could ultimately force restraint from shale drillers, pushing prices up in 2020.
Of course, much depends on how OPEC+ manages its next move. Russian President Vladimir Putin demurred on an extension of the cuts in the second half of 2019. Russia seems just fine with current oil prices, and is not in desperate need for higher prices like Saudi Arabia is. More to the point, the higher oil prices go, the more the cohesion around a strategy of production restraint begins to fall apart.
On top of that, the cuts have rebuilt spare capacity in a big way, which reduces supply risk and mitigates the risk premium given to prices.
Later this year, a series of Permian pipelines are scheduled to come online, which could unlock new production. Finally, non-OPEC production increases from Brazil, Norway, Guyana, Canada and Iraq are assumed next year.
Goldman summed up its argument by saying that what lies ahead for the oil market is basically a rerun of the 1990s, which the bank characterized as “tight spot markets but well supplied forward balances and reflected in steady backwardation with an anchored back-end.” Goldman sees backwardation in the futures curve as a thing that will stick around.
In short, there is upward pressure on prices now, but it may only temporary.