When Goldman Sachs first postulated that oil prices might fall to as little as $20 per barrel, many market participants were incredulous. Fast forward a few months though, and with oil below $30 a barrel, $20 does not look nearly so improbable.
Yet despite the fact that oil’s downward trend has gained momentum of late, Goldman Sachs seems to be largely unconcerned. The bank is sticking with its $40 per barrel forecast for the first half of 2016 and says that it sees a new bull market in oil starting to evolve in late 2016 as market adjustments balance out supply and demand.
Goldman’s view is noteworthy for two reasons. First, the firm’s $40 forecast is predicated on storage capacity not topping out given current production levels. The view that storage capacity could become an issue given the weakness in demand and excess supply is a common one that has been repeated often over the last year. From an economic standpoint though, it is difficult to put too much stock in such a prediction.
For instance, as oil supplies rise, it creates additional demand for storage capacity which in turn raises the price leading new storage supply solutions to come online. This can take the form of either new tanks built, or alternative equipment converted to oil storage – for instance pipelines and supertankers being used for storage rather than transport of crude.
Additionally, there simply was never enough clean and clear data to suggest that a storage space crunch was imminent. An awful lot of supply exists across the U.S. heartland and elsewhere, but there is no good way to monitor it. Satellite imagery is starting to change that reality, but for now we have at best rudimentary methods for estimating capacity utilization. Thus worrying about storage capacity at this juncture is something like worrying about the threat of an alien attack – we have no good evidence to suggest a problem is at hand.
Goldman’s view that storage capacity is not an issue unless the market sees an unexpected spike in production or fall in demand makes sense – markets do very well with supplying the needs of society when those needs are forecastable. As long as the oil glut continues to grow at a predictable pace, all should be well then.
The second notable point regarding Goldman’s view is the call for the start of a new bull market in late 2016. This should give some distant sense of hope to energy investors. Almost no oil producer on Earth can make money at present prices. Saudi Arabia and Iran in particular will likely keep pumping oil as a way of thumbing their nose at one another, but the Russians and the Venezuelans may find in short order that draconian financial adjustments are needed to keep their economies afloat without the traditional rich stream of oil revenues they have enjoyed. Similarly, while most oil companies survived the fall banking evaluations, 2016 will bring new challenges on that front.
Gary Shilling noted the dilemma here that producers find themselves in last year with what proved to be a very prescient call. At this point companies are not making money with oil at current prices. Instead they are continuing to operate in the hope that tomorrow will be better. They can do this until one of two things happen; they run out of cash for operating purpose, or they give up hope. It will probably take a combination of both factors to rebalance the markets.
By Michael McDonald of Oilprice.com
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