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Will Goldman Be Right After All?

Will Goldman Be Right After All?

In last week's key figures for the oil and gas industry, we see U.S. crude imports surge, especially on the Gulf coast. whereas U.S. domestic production is slightly up. U.S. average gasoline prices near the one dollardom, and U.S. crude stocks build.

Related: OPEC Members In Jeopardy, How Long Can They Hold Out?

After an up and down week, oil prices continued to slide again after the EIA reported a surprise uptick in crude oil inventories. While market analysts had predicted a drawdown, oil storage jumped by 4.8 million barrels, putting total inventories at 490.7 million barrels, less than 300,000 barrels shy of the 80-year record set in April of this year. That was enough to push WTI below $35 per barrel on Thursday.

Some corners of the energy world dismissed Goldman Sachs’ prediction earlier this year that crude oil prices might fall below $30 per barrel. But no longer. The investment bank reiterated its belief that oil prices may need to fall to $20 per barrel in order to force a significant volume of supply off the market, and such a scenario is no longer seen as a remote possibility. U.S. oil production has only declined moderately thus far, down about 300,000-500,000 barrels per day since peaking at 9.6 million barrels per day (mb/d) in April 2015. But with so many drillers barely hanging on, everyone is still pumping as much oil as possible in order to keep the lights on, delaying the inevitable adjustment in supply. “This rebalancing is far from achieved,” Goldman concluded this week.

The investment bank says that only prices plummeting to $20 per barrel will force a much greater volume of oil offline, a necessary development to balance oil markets. That would be extremely painful for individual drillers and for the economies (local, state and national) that depend on oil revenues, but without such a severe drop in prices, the oil markets could endure a more damaging prospect – a protracted supply overhang, which could end up being much worse for all those concerned. For now, the world is still producing somewhere around 1.5 mb/d more than it needs. Capital markets have shunned some of the most indebted drillers, but access to finance remains open for investment-grade oil drillers. In this context, unless oil prices drop another $10 to $15 per barrel, Goldman says, the necessary contraction may not take place quick enough. Related: Lithium: The Bright Spot For The Commodity Sector

As we noted earlier this week, the U.S. Congress is poised to lift the 40-year old ban on crude oil exports. At the time of this publishing, the outcome of the vote was still not decided, as some conservative members of the House of Representatives balked at the budget and tax package because of what they see as excessive spending. On the Democratic side, some members opposed lifting the ban on environmental grounds. The vote will be an early test for the speakership of Rep. Paul Ryan (R-WI). Assuming the bill is passed (and subsequently clears the Senate and is signed by the President), the removal of the ban on oil exports could permanently diminish the spread between Brent and WTI, smoothing out regional differences in oil supply and demand. It will mark a major legislative victory for oil and gas producers, who have at times suffered from too much oil trapped within the United States. Still, most analysts do not see a massive ramp up in exports in the near- to medium-term. The immediate effect on prices should be to slightly push up WTI and slightly push down Brent, but those effects are more likely to be overshadowed by other market factors, such as the aforementioned build in inventories, ongoing production figures from the EIA and OPEC, or simply broader macroeconomic trends.

As expected, the U.S. Federal Reserve ended a seven-year period of near-zero interest rates this week. The decision was a bit of a mixed bag for oil markets. On the one hand, higher rates should strengthen the dollar (and thus push down oil prices) and raise the cost of capital, two effects that are clearly negative for oil producers. On the other hand, the Fed also expressed confidence in the U.S. economy and also pointed to a willingness to move very gradually. The central bank signaled intentions to raise rates four times in 2016. Having already delayed the rate hike by quite a bit, the move was hardly a surprise and the markets reacted in positive fashion, with equities rising around the world immediately following the announcement on Wednesday.

An El Nino weather pattern has led to unusually warm weather across the entire eastern seaboard of the United States. The warm spell comes at a very inopportune time for energy markets, depressing winter heating demand at a time of abundant supply. As a result, natural gas prices sank to 17-year lows this week. In fact, while many market watchers focus on oil inventory levels, natural gas storage levels are filled to the brim. In November, natural gas storage topped 4 trillion cubic feet, and the seasonal drawdown has gotten off to a very late start. Storage levels are still well above the running five-year average, which stems not just from record high temperatures, but also from record high production across U.S. shale gas fields this year. Natural gas markets are now decidedly suffering from a supply overhang, and Henry Hub spot prices have dipped below $1.80 per million Btu, the lowest level so far in the 21st Century. That is very bad news for natural gas drillers such as Chesapeake Energy (NYSE: CHK), many of which are struggling to deal with mountains of debt. Related: Strong Dollar, Warm Weather, Full Storage Keep Prices From Breaking Trend

The IEA published a report on December 18 that suggests that China’s coal consumption may have reached a peak. The slowing economy, lower industrial activity, combined with efforts to reduce air pollution have slashed China’s coal consumption much faster than anyone has anticipated. But the problem for the coal industry goes beyond China. “The economic transformation in China and environmental policies worldwide – including the recent climate agreement in Paris – will likely continue to constrain global coal demand,” IEA’s Executive Director Fatih Birol said in a statement.

Finally, Mexico announced plans to hold a deep-water auction in 2016 to sell off some sought after blocks in the Gulf of Mexico. The fourth of five planned installments of its “Round One” auction will offer 10 blocks that are located close to prolific oil projects just across the maritime border on the American side of the Gulf of Mexico. For example, Royal Dutch Shell (NYSE: RDS.A) operates a massive deep-water drilling project in the Perdido Belt nearby. As such, many believe that the blocks on offer hold very large volumes of oil and gas. Mexico already has held three auctions as part of the Round One sale, two shallow water auctions and a recent auction for onshore tracts. But the deep-water auction will be the most anticipated, as it holds about 75 percent of Mexico’s oil potential. Mexico plans on holding off until late 2016, hoping that oil companies will express more interest once oil prices turnaround.

By Evan Kelly of Oilprice.com

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