The Fuse

Oil Market Set to Tighten, Then Fall Back

by Nick Cunningham | February 27, 2019

A confluence of factors is tightening up the oil market. OPEC+ is holding back supply, Venezuela is likely suffering from major disruptions, demand is growing at a steady pace, and the U.S. and China just delayed their trade war. In a few months, U.S. sanctions on Iran may tighten the screws further.

A growing number of analysts see more price gains ahead for crude oil in the near future. However, the bullish trend may only prove to be fleeting, with the possibility of another downturn later in the year.

Brent to $75
President Trump may want OPEC to “relax and take it easy,” but the group seems determined to keep the 1.2 million barrels per day (Mb/d) in supply cuts agreed to in Vienna in place. Saudi oil minister said that oil inventories in the U.S. are “brimming,” likely requiring OPEC to maintain market management throughout the year. “All of the outlooks that I have seen tell us that we will continue, we’ll need to continue, to moderate production in the second half of this year,” Al-Falih told reporters in Riyadh. In direct response to Trump’s tweet, al-Falih said: “We are taking it easy; 25 countries are taking a very slow and measured approach.”

However, despite that line of argument, OPEC+ is taking a more aggressive approach than in the past, according to a new report from Goldman Sachs. OPEC’s “shock and awe” strategy, as Goldman frames it, is intended to drain the oil supply surplus quickly. This stands in contrast to the group’s actions in 2017, with cuts phased in over time. That allowed for only a gradual elimination of the surplus, and it wasn’t until the third and fourth quarter of that year that the market started tightening up and oil prices began to budge.

This time around, Saudi Arabia is cutting deeper than it is required to do as part of the December OPEC+ agreement in Vienna. “Cut real deep, real sharply, rebalance the market quickly, and get back to a market share strategy before the shale guys take away their market share,” Jeffrey Curie, head of commodities research at Goldman Sachs, said on Bloomberg TV, referring to OPEC’s strategy at the start of 2019. “Because that was the mistake they made back in ’16 and ’17. It was the long, drawn cut that extended over a year or so. And in that time period you ended up with 700,000 barrels per day of extra shale output.”

Saudi Arabia plans to lower its output further in March, indicating it will aim for 9.8 Mbd, or roughly 0.5 Mbd lower than it committed to in Vienna. Even as the Saudi oil minister says the group is taking a measured approach, Goldman Sachs analysts argue that OPEC’s strategy is likely aimed at quickly draining the surplus and then exiting the supply curbs as soon as June, with the aim of trying to avoid creating too much runway for U.S. shale growth.

Against this already bullish backdrop, other outages are hitting the market. Goldman estimates that absent a political resolution, Venezuela could lose another 200,000 to 300,000 barrels per day (b/d) in the coming months. The waivers for U.S. sanctions on Iran expire in May, which could result in more supply disruptions, although the tightening market could restrain the Trump administration’s more aggressive impulses.

On the current trajectory, Brent could “easily” continue to rise to a $70-$75 per barrel range, Goldman argues.

Oil rally could be “fleeting”
While prices are on the upswing, the bullishness could be “fleeting,” Goldman Sachs says. U.S. shale continues to surprise, with the major energy forecasters such as the EIA having recently been forced to revise up its estimate for supply growth this year. The agency said in its February Short-Term Energy Outlook that the U.S. could average 12.4 Mbd this year, up 300,000 b/d from its prior estimate. A series of pipelines in the Permian are scheduled to come online in late 2019, which could pave the way for another round of drilling. Supply growth is also set to come from Brazil this year, with the inauguration of a major project helping the country to add more than 350,000 b/d.

Meanwhile, OPEC+ may exit its supply curbs and fight for market share once again. Due to the “unconstrained shale output, rising low cost OPEC+ output,” Goldman says that Brent prices could fall from the $70-$75-per-barrel range in the second quarter to just $60 per barrel by the end of the year.

Moreover, even that downbeat price forecast is subject to bearish risks. Most notably, the potential for a global economic downturn could spoil demand forecasts. At this point, Goldman Sachs and many other forecasters, including the EIA and the IEA, see demand growing at rather robust 1.4 Mbd. That figure could fall dramatically if the economy takes a turn for the worse.

There is no shortage of geopolitical and economic risks. The U.S.-China trade war has been delayed but not ended. The ongoing uncertainty over Brexit also appears far from a resolution. The U.S. is also mulling auto tariffs on the European Union. “The key point is that while some of the bad tail risks have been reduced or even eliminated, the lack of clear outcomes maintains overall economic uncertainty that ultimately acts as a drag on capital investment,” Goldman warned.

In short, Brent could be set for a rise above $70 per barrel in the next two or three months, but the investment bank expects prices to fall back to $60 in the latter half of the year.