Goldman Now Expects OPEC To Reach Production Cut Deal, Raises Q1, Q2 Oil Price Forecast; Cuts Q3, Q4
Monday, 21 November 2016 Among the reasons for today's rebound in oil prices, as noted earlier, is renewed hope that OPEC will reach a deal during the cartel's upcoming meeting in Vienna on November 30. The catalysts include Iraq and Iran, both of whom signaled optimism surrounding the proposed OPEC supply-cut deal, while Russian President Vladimir Putin said his nation is ready to freeze crude output at current levels, and sees no obstacles to an agreement.
To emphasize this, moments ago Putin was quoted by newswires as reiterating a position he laid out over the weekend:
· RUSSIAN PRESIDENT PUTIN SAYS WILL NOT BE DIFFICULT FOR RUSSIA TO FREEZE OIL OUTPUT
· RUSSIAN PRESIDENT PUTIN SAYS CANNOT SAY IF OIL FREEZE DEAL WOULD BE REACHED 100 PERCENT
On the other hand, Iraq, OPEC’s second-biggest producer, said it would offer proposals this month to help the producer group reach an agreement on an output freeze to shore up prices. Curiously, there was no mention of Iraq actually agreeing to cut production and by how much, or just how much of the delta to 32.5 mmbpd Saudi Arabia is willing to absorb.
As Bloomberg notes, details of the Iraq proposals were not provided in an e-mailed statement from the Iraq Oil Ministry on Monday, probably for a simple reason: there were none, as OPEC's strategy remains simple: jawbone shorts into further covering ahead of the OPEC meeting. The nation’s “legitimate demands” shouldn’t be considered as obstacles to reaching an accord, Oil Minister Jabbar al-Luaibi said in the statement.
Iraq has sought an exemption from joining any production cuts, arguing that its fight against Islamic State justifies special treatment. The Organization of Petroleum Exporting Countries agreed in September in Algiers to cut their collective output to 32.5 million to 33 million barrels a day. While quotas will be decided at OPEC’s Nov. 30 meeting, Libya, Nigeria, Iran and Iraq have said they should be exempt.
“Iraq’s legitimate demands should not be perceived as an obstacle to reaching a new agreement to freeze production,” al-Luaibi said in the statement. Iraq looks forward to “reaching a fair agreement that would take into consideration everyone’s interests and that puts an end to the glut.”
Iraq will take “new proposals and ideas” to OPEC this month to help members reach an accord, al-Luaibi said in the statement. An agreement will “help achieve the common objectives of the producers, including market stability and shoring up prices to acceptable levels.”
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And while OPEC skeptics have traditionally laughed off such repeated "optimism-based" jawboning by OPEC, especially coming at times of an aggressive buildup in shorts (which as Morgan Stanley has pointed out tends to be a catalyst for the oil cartel to start a barrage of flashing red headlines meant to launch momentum among the stop hunting algos), this time something is different: overnight a new development emerged when Goldman upgraded its near-term oil price targets as it now expects OPEC to come through.
In a note from Goldman's Damien Courvalin, the Goldman analyst said that as a result of "sharply weakened oil fundamentals" since OPEC announced a tentative agreement to cut production, Goldman now expects "a large surplus of 0.7 mb/d in 1Q17 in the absence of such a cut." As a result, "*there is now a stronger economic incentive for OPEC producers to prevent a further rise in inventories in 1H17 and instead act to normalize the current high level of inventories through a short duration production cut. *We believe that such a cut will likely generate backwardation – helping them grow market share by sidelining higher cost producers – as as well as reduce oil price volatility – which should increase the valuation of the debt and equity they are issuing. In our view, the goal of normalizing inventories should however not target elevated oil prices as the flattening of the oil cost curve and the unprecedented velocity of the shale supply response would make such an endeavor rapidly self-defeating above $55/bbl."
As Goldman acknowledges, this is a change from its recent outlook:
*As of late September, we did not believe that the conditions were in place for an OPEC production cut to work*: production disruptions were starting to reverse, Iraq and Iran were reporting and aiming for higher production and we expected non-OPEC production to grow into year-end (see Beyond Algiers, weakening oil fundamentals, September 27, 2016). Two months later, with most of these supply expectations having played out and prices near our $43/bbl 4Q16 forecast*, we now believe the odds of an OPEC cut succeeding are higher: (1) prices near the low end of their recent trading range likely incentivize cooperation; (2) post the October ramp up, OPEC production is closer to capacity; (3) while we now expect a large surplus of 0.7 mb/d in 1Q17 in the absence of a cut, we are more confident that the global oil market will shift into deficit by 2H17 even at elevated OPEC production levels, on the combination of stronger expected demand growth and lower production from countries in decline; and (4) we have further evidence of delineation in the global cost curve near $50/bbl, with $55/bbl likely required for higher cost producers to ramp up activity.*
What does this mean for markets:
For the purpose of our oil price forecast, *our base case is now that an OPEC production cut will be announced and implemented with OPEC production at 33.0 mb/d in 1H17 and a Russia freeze at 11.6 mb/d. *As we have flagged previously, this leads us to reverse the direction of our 2017 oil price path, although not the annual average level, which remains at $52.5/bbl for WTI. Specifically, normalizing inventory levels will generate backwardation by 2Q17 and *leads us to raise our 1Q and 2Q17 WTI price forecasts to $55/bbl from $45/bbl and $50/bbl previously.*
However, Goldman also admits that the early rebound in oil prices will push more shale oil into markets, leading to lower oil prices over the longer-term:
* We reduce our 3Q and 4Q17 forecasts to $50/bbl
(from $55/bbl and $60/bbl previously) on an expected resumption in OPEC
production growth and a US shale supply response to the 1H17 rally.*
Some of the visualizations behind the latest Goldman change of heart:
Even so, Goldman hedges accordingly: "Of course, political risks can still derail an otherwise economically sound decision and we believe an outcome where OPEC does not agree to a cut is near-term bearish – even from current price levels – as it implies greater sequential production from the group in competition for revenues and market share."
Traditionally, this would mean that Goldman is now selling oil to its clients who have been advised to load up. Whether this time is different will be revealed in less than 10 days.
Even if OPEC agrees to a production cut at next week's meeting, it won't be a seismic development for oil prices. "OPEC has been playing a big role in the price of oil over the last few months," said David Lebovitz, global markets strategist at JPMorgan Asset Management. "To us, it's much more about...
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