Oil prices continue to plumb new depths, but some analysts think the selloff has gone too far.
Brent prices fell to $62 per barrel by mid-week, hitting nearly a one-year low. The bearish narrative has taken hold in a big way, with rising U.S. shale production, record output from Saudi Arabia, rising inventories and faltering demand growth all combining to drag down crude prices. “The bears still have the oil market firmly in their grip,” Commerzbank said in a note on Thursday. “No end to the downswing is in sight for the foreseeable future.”
But are prices dropping too far, too fast? Some analyst think so. “[T]he oil market sell-off has overshot current and forward fundamentals,” Goldman Sachs wrote in a note on November 20.
Goldman Sachs believes that the most recent selloff, which saw Brent drop below $60, came with “no new fundamental data,” suggesting that the drop reflects a confluence of factors including expectations of a glut in 2019, speculative trading, low trading activity ahead of the Thanksgiving holiday as well as the broader selloff in global equities.
Still, the fundamentals have been trending in a bearish direction. And even though OPEC+ has sent signals that a production cut is on the table, other bits of news have been negative. Libya expects to be exempted from the production cut, and its output continues to rise steadily. Venezuela’s output fell by less than expected in October. Iraq and Kurdistan just agreed to allow for some oil – up to 100,000 bpd initially – to resume flowing through a Kurdish pipeline. If the tentative agreement holds and the two sides build on it, another 200,000 bpd could follow.
It will take a “fundamental catalyst for prices to stabilize,” Goldman argues. “While we expect prices to eventually recover, we continue to expect high price volatility until evidence that the oil market fundamentals are improving, requiring a decline in OPEC production and signs that demand growth is resilient.” Related: Plunging Oil Prices Weigh On Saudi Bonds
The Brent futures curve has flattened significantly, and Goldman argues that for spot prices to rise, the futures curve will have to move back into a stronger backwardation – a situation in which near-term prices trade at a premium to longer-dated oil futures. The good news for oil prices it that the “current data does not justify” the recent and sudden flattening of the curve, Goldman analysts argue. That is because “inventories are not elevated, demand growth is likely to beat low expectations, Iran exports will decline further and ultimately core OPEC will reduce output in our view.”
But prices are also down because of expectations of a growing supply glut in 2019. U.S. shale continues to surprise the market, beating even optimistic forecasts of production growth. Supply disruptions continue to decline, most notably in Libya. Meanwhile the expected output cut form OPEC+ will also allow for a rebuilding of spare capacity, reducing supply risks going forward. “This effectively reverses the perceived need since May for high-cost marginal barrels to compensate for Permian bottlenecks and Iran export losses,” Goldman Sachs wrote. Related: Does The U.S. Really Need Saudi Oil?
The investment bank said that its expectation that prices will recover could be wrong due to two factors. First, the global economy could enter a downturn and demand collapses. Or, OPEC+ decides not to cut at all at the upcoming meeting, which leads to a significant supply glut heading into 2019.
Looking out over the next year, OPEC+’s problems get even trickier. They could decide to flood the market, which would likely crash prices, but that would crush their own budgets. Meanwhile, U.S. shale is poised to add a flood of new supply next year. As Bloomberg notes, the shale industry has already vastly exceeded expectations in 2018, and shale companies have not slowed down. They are drilling new wells now, but only completing some of them. E&Ps are keeping some wells uncompleted, awaiting new pipelines in 2019. When those projects come online, another wave of fresh supply could be unleashed. “We’re going to see a re-acceleration of well completions in the Permian in the second half of 2019,’’ Corey Prologo, head of oil trading in Houston at commodity merchant Trafigura Group Ltd., told Bloomberg. “The pipelines are going to fill up very quickly.’’
OPEC+ could decide to cut output in December to stop the slide in oil prices. But their task gets no easier as we head into 2019.
By Nick Cunningham of Oilprice.com
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