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Nick Cunningham

Nick Cunningham

Nick Cunningham is a freelance writer on oil and gas, renewable energy, climate change, energy policy and geopolitics. He is based in Pittsburgh, PA.

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Goldman: Don’t Bet Against Oil

On Thursday, Brent topped $80 per barrel for the first time since November 2014, breaching a psychological threshold amid tightening inventories and widening geopolitical risk.

Yet, even as oil prices have rallied to their highest point in three and a half years, investors have pared back their bullish bets on oil futures. Hedge funds and other money managers have cut their long positions for several consecutive weeks, perhaps as a bit of profit-taking, or maybe because the bullish positioning had appeared to have gone too far.

Indeed, investors pushed their net-length to record heights, but that has been whittled down a bit over the past month. That reduction has occurred even as oil prices have broken new multi-year record highs.

But betting that oil prices have hit a ceiling and liquidating bullish positions is a “dangerous” game, according to Goldman Sachs. The investment bank noted in a recent report that commodities are the “best performing asset class” posting “the best [year-to-date] returns in a decade.” Getting out now hardly makes sense.

“The rally likely has room to run, particularly from a returns perspective. Oil fundamentals are now more bullish as robust demand faces supply disappointments,” Goldman wrote in a note to clients. The bank hiked its expected returns on commodities over the next 12 months to 8 percent, up from 5 percent previously.

Venezuela is melting down, a sizable chunk of Iranian supply is at risk, supply losses in Angola have been larger than expected, and Brazil’s production growth has disappointed. Goldman says that there could be a 1-million-barrel-per-day supply gap as soon as this summer. Related: Skeptic Geologist Warns: Permian’s Best Years Are Behind Us

More importantly, OPEC won’t preemptively act to mitigate the loss. History suggests that OPEC will have trouble catching up to that gap and keeping the oil market balanced – they tend to act too late when prices have already spiked. “In 2000, OPEC added 3.0 mb/d of supply against late cycle growth and returns were 51 percent as supply never caught demand and the U.S. had to use the SPR at year-end,” the investment bank wrote.

Moreover, any added supply from OPEC will help replace lost barrels from elsewhere, but it will also cut down on the group’s remaining spare capacity.

Goldman analysts shrugged off any concerns about demand destruction, painting a bullish picture for oil prices. “Growth concerns will likely prove temporary, realized demand remains robust and OPEC has never been able to catch late-cycle demand growth to replenish inventories before a recession occurs,” Goldman analysts wrote. “And even if growth were to decelerate further, it would take global GDP growth collapsing to 2.5 percent yoy to simply balance the oil market! We recommend not ‘riding this one out.’”

The bank also added that higher oil prices tend to lead to an expansion of credit in emerging markets, stoking growth further. In other words, higher commodity prices are beneficial to a lot of emerging market economies, which keeps the rally going for a while before a recession occurs. “Higher oil price leads to higher excess savings by the oil states, higher ex-US dollar liquidity and more dollar credit,
which in its turn boosts [emerging market] demand and leads to higher oil prices,” Goldman said. Related: The Most Underappreciated Story In The Oil Market

All that means that the case for high returns from commodities is strong. Returns for investors in commodities are the best in a decade, “surpassing the returns of 2011 when the Arab Spring created a supply shock in Libya.” This cycle is different, Goldman argues, because the upswing is being driven by strong demand rather than an unexpected supply outage. Except, supply outages are now cropping up as well (Venezuela and potentially Iran), making the outlook for oil “more bullish than we had expected.”

The U.S. is the only source of supply growth that could fill the gap but even the prolific shale industry won’t be able to resolve the brewing supply crunch. Pipeline constraints could slow growth in the Permian by next year.

“Without aggressive action by OPEC/Russia, markets would likely remain in deficit and inventories would draw to critical operating levels by 1Q19,” Goldman Sachs analysts wrote.

By Nick Cunningham of Oilprice.com

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  • Kr55 on May 17 2018 said:
    Spec longs taking profits while oil doesn't drop is a good sign. It's likely due to short hedges slowing, and long hedges ramping up. The difference between long and short spec positions is similar to the difference between short and long hedges. Long hedges are way behind the 8-ball, and if they're smart, they would start locking in more of their purchase prices for oil.
  • Bill Simpson on May 17 2018 said:
    No way Texas Permian basin oil can replace the combination of oil lost from Venezuela + oil cuts by OPEC members + oil cut by Putin. The oil price is going higher, maybe all the way to $95 a barrel by August. That will probably cause a recession before 2019 ends.
  • petergrt on May 17 2018 said:
    Goldman must be still hoping to handle the Aramco IPO . . . .

    Considering the recent strength of the USD, Brent is at about $90 when priced in Euros . . .!

    To suggest that at this price the demand will not be affected is just silly.

    With respect to the Iranian oil sanctions, I dare say that there will not be one barrel taken off the market. Chinese will take whatever they can take and Europeans are setting up systems to circumvent any US sanctions. The bottom line is that much of Iranian oil will be traded outside of the USD universe. In fact, Iran is now freed to pump as much as they physically can as the OPEC imposed limits were in essence vacated.

    Venezuela implosion - many of their oil producing assets will be taken over by creditors as Russia, China and others, and thus production can be fairly quickly restored.

    Anyway, it virtually impossible to find a bearish view / article about the price of oil. Such unanimity occures
  • andy macpher on May 18 2018 said:
    Are these are the same geniuses who not so long ago were telling us that the oil price will never go up again. The demand for oil is huge, without oil the world will go back to the dark ages. Talking it down through the media like they always try so hard to do, wont make us believe otherwise. Its simple supply & demand. Oil is and always will be the main fuel of the future.
  • Mamdouh G Salameh on May 18 2018 said:
    I project oil prices have still a long way to go before they settle down. Moreover, I am also glad that Goldman Sachs has the same sentiments.

    I would not be surprised if oil prices go beyond $80 a barrel in 2018, rising to $85-$90 in 2019 and hitting $100 if not higher in 2020. Prices are currently in the best situation in terms of economics and geopolitics.

    They are overwhelmingly supported by very positive fundamentals in the global oil market, a virtually re-balanced market and, to a lesser extent, rising geopolitical concerns. Still, I hasten to add that current geopolitical concerns such as the forthcoming sanctions on Iran, Venezuela’s production decline and escalating tension between Saudi Arabia and Iran have already been factored in by the oil market long time ago so their impact on oil prices is very limited possibly amounting to $1-$2/barrel.

    However, three major factors will continue to give oil prices added support. One is the continued OPEC/non-OPEC production agreement well into the future in one form or another. OPEC and Russia have at last found a successful and workable mechanism to virtually put an end to future glut or at least mitigate its impact on prices.

    Another is that OPEC members and Russia are starting to believe in the sound economic principle of aiming to maximize the return on their finite assets to the highest level the global economy will allow them.

    A third factor is the brewing confrontation between the petro-yuan and the petrodollar. Other than challenging the petrodollar for dominance in the global oil market which is in itself a very serious threat to the US economy and financial system, the petro-yuan is already starting to serve as a refuge to countries threatened by US sanction like Iran. In effect, the petro-yuan is nullifying US sanctions.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • David Jones on May 18 2018 said:
    We know from experience that Goldman Sachs can't see past their own nose when the green glow of short term cash is stapled to it. Their short term projections may be valid but their long term dreams are likely just that. My guess is that as time goes on, we will see continuing divestment happen even as the oil industry posts rosy numbers because if you remove the blinders, the wider long term situation fundamentally does not support the product so the more the prices rise the greater the chance for divestment as investors step out with a profit, the greater chances for market share loss due to alternatives and the higher the probability of eventual industry collapse as the need for the product diminishes.
  • Really? on May 18 2018 said:
    Goldman has been hired to handle to Saudi Aramco IPO. Of course they are going to do everything they can to manipulate oil prices upwards. Keep that in mind when reading anything Goldman has to say about oil.
  • Neil Dusseault on May 18 2018 said:
    Yes, folks...don't bet against oil!

    Said from Goldman Sachs--you don't suspect they have any long positions in crude futures, do you?

    Let's just turn this market into a one-way trading platform, where the price is never allowed to go down but only ever go up. Why? Well, let's take a look:

    So many sites have headlines on oil that are still saying that the price is high due to Iran sanctions. Yet this particular site has posted numerous articles highlighting the fact that the U.S. oil supply will NOT be affected by these sanctions as most Iranian crude goes to Asia and Europe and Saudi Arabia is happy to pick up their market share should there be any supply disruptions in the future.

    Then are we all supposed to ignore those articles and let those other sites promote headlines about Iran sanctions every day for the rest of the year?

    What about weekly Baker Hughes oil rig count data on the rise? U.S. production every week making record highs?

    Personally, I think the market is focused on one thing: $80 - $100. Once that was suggested by the Saudis, that's all that Goldman Sachs and hedge fund managers are heading towards (e.g., the ones with the largest long positions right now which set the trends in the market).

    Never mind global economies, and by people paying more for the same stuff I mean the fact that oil is up 70% since last Summer (up $30/bbl in months) or that the price of WTI has nearly tripled in just 2 years. Nope. Apparently that's not high enough yet, so let's all get there as fast as possible.
  • Mamoud al Salim on May 18 2018 said:
    The North American advantage in oil price can only grow, a big strategic advantage for the Yanks and Canucks. The advantage in gas prices for North America is astronomical and blasting higher. Industry from around the world is moving to where the cheaper energy is, and that's bad news for Europe.
  • David Clarke on May 21 2018 said:
    Sadly for Canada however, our leader in Ottawa will let the developed world leave us in the dust. Canadians consider it a pretty good day if he does not open his mouth, unless he eats another crayon.
  • norman.e.nabatar on May 22 2018 said:
    We know that the supply situation is artificial. OPEC oil supply may suddenly surge, if and when the peace situation stabilizes. The US troops northwest of Syria have reportedly been withdrawn, but who is securing the oil fields in Kurdistan? That is a volatile situation that can spell the return of ISIS.

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