Echoing commentary published here during the weekend, overnight Goldman's chief commodity Jeffrey Currie repeated his recommendation to overweight allocation to oil to "hedge against increased geopolitical risks, driven by elevated US-Middle East tensions" which as of this weekend, have "broadened to include Saudi Arabia."
Specifically, Goldman now believes that "the balance of risks given the potential magnitude of supply shortfalls from Iran in the short-term or Saudi potentially outweighs for now a backdrop of weaker fundamentals and increased macro uncertainty.
Although our 12m forecast for the S&P GSCI now stands at 3%, we still see significant portfolio value in staying long and including commodities in a diversified portfolio, particularly given the geopolitical environment."
Earlier on Monday oil spiked after Saudi Arabia vowed a strong retaliation amid the latest back and forth between the US and Riyadh.
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Still, one should not overplay the potential of a Saudi-induced price spike, and Currie warned that focusing on near-term geopolitical tensions and trading volatility risks missing the core reason for being long commodities late cycle: "they are a hedge against rising interest rates and are one of the few assets which outperform in the late-cycle."
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Furthermore, in terms of its bullish price outlook, and separate from the Saudi escalation, Goldman noted that elevated uncertainty around this politically-engineered market tightening is due to the potential timing or size mismatch of the Iran declines and new capacity coming online as well as the uncertain stance of the US administration on waivers. Related: Will China’s “Debt Diplomacy” Backfire?
This has driven consumer hedging and investor buying, with producers not inclined to hedge given trending prices and the diminishing activity of HY independents. The risks are therefore that long-dated prices continue to drift higher, keeping spot prices above our year-end $80/bbl forecast until producer hedging resumes.
Looking further ahead, Goldman expect prices to sequentially decline to $70/bbl next summer as a wave of new Permian production comes online, and expects Brent-WTI spreads to remain wide until such new capacity comes online as Brent prices need to outperform to cover the costs of sending crude to the USGC by rail. Finally, as Permian constraints ease, Currie expects the WTI-Brent spread to normalize to $5.5/bbl in 2H19."
Going back to Goldman's Saudi warning, what was odd is that the bank recommended staying long even though its year-end target for Brent of $80 is slightly below current prices. There may be a good for that: as we noted earlier, Goldman's flash update followed an escalation in rhetoric in which Trump threatened Saudi Arabia with severe punishment if it is found that the Saudis were involved in Khashoggi disappearance and/or death, sending Saudi stocks plunging the most since 2016.
In response, Riyadh made a not so veiled threat to use the kingdom’s oil wealth as a political weapon - something which Bloomberg said was "unheard of since the 1973 Arab embargo that triggered the first oil crisis."
On Sunday, Saudi Arabia said on Sunday it would retaliate against any punitive measures linked to the disappearance of Washington Post columnist Jamal Khashoggi with even “stronger ones." In an implicit reference to the kingdom’s petroleum wealth, the statement noted the Saudi economy “has an influential and vital role in the global economy.”
Additionally, the fact that the Arabiya article was published only minutes after Saudi Arabia’s press release was issued led many to conclude it was either a message conveyed outside diplomatic channels or a trial balloon that quickly went flat.
Roger Diwan, a longstanding OPEC watcher at consultant IHS Markit Ltd., said the Saudi comments broke “an essential oil market taboo.”
While few think that Saudi Arabia is prepared to follow through, even the suggestion of using oil as a weapon undermines Riyadh’s long-standing effort to project itself as a force for economic stability. Jeffrey Currie, the head of commodities research at Goldman Sachs Inc., said Middle East tensions impacting the oil market have now "broadened to include Saudi Arabia." Related: Barclays: $70 More Likely Than $100
The tensions were exacerbated by an article written by Turki Al Dakhil, who heads the state-owned Arabiya news network and is close to the Royal Court, in which he openly talked about using oil as a weapon.
“If President Trump was angered by $80 oil, nobody should rule out the price jumping to $100 and $200 a barrel or maybe double that figure."
As we noted overnight, the Saudi embassy in Washington later said Al Dakhil didn’t represent the official position of the kingdom and Saudi officials, speaking privately, said there wasn’t a change in the long-held policy that oil and politics don’t mix.
In an attempt to further defuse the tense situation, on Monday, Khalid Al-Falih, the Saudi energy minister pledging his country will continue to be a responsible actor and keep oil markets stable, during a speech in India.
"I want to assure markets and petroleum consumers around the world that we want to continue support the growth of the global economy, the prosperity of consumers around the world," Al Falih said.
On Sunday, Saudi Arabia said it’s begun an internal investigation into the disappearance Khashoggi at its Istanbul consulate and could hold people accountable if the evidence warrants it. This was followed by a Trump tweet in which he said that he has spoken to the Saudi King who denied any knowledge of whatever may have happened “to our Saudi Arabian citizen" and that he was working closely with Turkey to find answer. Trump also said that he is "immediately" sending Secretary of State Mike Pompeo to meet with the Saudi King.
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