While we await every new headline out of Algiers, overnight Goldman threw in the towel on its “transitory” oil market bullishness, and in a note by Damien Courvalin looking “Beyond Algiers, Weakening Oil Fundamentals”, the bank cut its Q4 oil price target from $50 to $43, as the bank admits the previously anticipated rebalancing will take longer to achieve, and now expects “a global surplus of 400 kb/d in 4Q16 vs. a 300 kb/d draw previously.“
Speaking of the Algiers meeting, Goldman also notes that “while a potential deal could support prices in the short term, we find that the potential for less disruptions and still relatively high net long speculative positioning leave risks skewed to the downside into year-end. Importantly, given the uncertainty on forward supply-demand balances, we reiterate our view that oil prices need to reflect near-term fundamentals – which are weaker – with a lower emphasis on the more uncertain longer-term fundamentals.”
Here is the summary from Courvalin:
Oil prices have remained range bound ahead of the OPEC consultation in Algiers this week and as production disruptions have yet to meaningfully ramp up. Statements by participants suggest potentially greater collaboration between OPEC members than in previous attempts, although the outcome of this advisory meeting remains uncertain. Our production forecast continues to reflect a seasonal Saudi production decline into year-end and no growth elsewhere (the equivalent of a deal) with OPEC exc. Libya/Nigeria production growth only resuming in 1Q17.
Nonetheless, our 4Q16 oil supply-demand balance is weaker than previously expected given upside surprises to 3Q production and greater clarity on new project delivery into year-end. This leaves us expecting a global surplus of 400 kb/d in 4Q16 vs. a 300 kb/d draw previously. Importantly, this forecast only assumes a limited additional increase in Libya/Nigeria production of 90 kb/d vs. current estimated output. As a result, we are lowering our 4Q16 forecast to $43/bbl from $50/bbl previously. While a potential deal could support prices in the short term, we find that the potential for less disruptions and still relatively high net long speculative positioning leave risks skewed to the downside into year-end. Importantly, given the uncertainty on forward supply-demand balances, we reiterate our view that oil prices need to reflect near-term fundamentals – which are weaker – with a lower emphasis on the more uncertain longer-term fundamentals.
Despite a weaker 4Q16, our 2017 outlook is unchanged with demand and supply projected to remain in balance. We expect demand growth to remain resilient while greater than previously expected production declines in US/Mexico/Venezuela/ Brazil/China are offset by greater visibility in the large 2017 new project ramp up in Canada/Russia/Kazakhstan/North Sea. While our price forecast remains unchanged at $52/bbl on average for next year with a 1H17 expected trading range of $45-$50/bbl, we continue to view low cost and disrupted supply as determining the path of an eventual price recovery with our forecasts conservative on both. As we wait for headlines from Algiers, it is worth pointing out that Iran, Iraq and Venezuela have each guided over the past month to a 250 kb/d rise in production next year.
And then there is the demand side:
July and August data point to demand growth slowing in line with our expectation, in particular in China. We forecast demand growth to average 0.9 mb/d yoy in 3Q, down from its torrid 1H16 pace of 1.8 mb/d. Our expectation for moderating demand growth in 2H16 is driven by strong base effects, a slowdown in growth and continued switching of power generation away from oil in Japan, Brazil and Mexico. Note that our demand estimate remains higher than the IEA’s however given our corrected measure of Mexican demand1. and our expanded accounting of Chinese demand.
To summarize, in Goldman’s base case, the bank’s “forecast continues to reflect a combined decline in OPEC production (exc. Libya and Nigeria) of 340 kb/d in 4Q16, with growth of only 140 kb/d in 1Q17. Despite this forecasted help from OPEC, we find that the improvement in oil fundamentals has stalled in 3Q and that the inventory build is set to resume in 4Q, a weaker outlook than we had previously expected.“
So given Goldman’s outlook for a well supplied market and a crude curve in contango with limited spot upside, it “continues to recommend being short the S&P GSCI Crude Oil index, especially paired with positive yielding oil-exposed assets such as HY E&P credit.“
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Normally, this would suggest buying oil here, which is what Goldman’s flow traders will be doing, however considering the significant volatility potential out of Algiers over the next 48 hours, it may be best to just sit back and observe if only for a few days.
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