Some market watchers, such as Cornerstone Analytics (CA), have consistently stated that the underestimation of demand, coupled with over-estimation of supply, will mask the growing call on OPEC oil in the second half of this year. CA recently noted that global demand outstripped supply by some 4 million barrels in April . This comes in addition to the mounting evidence that the oil market, via rig count declines, slowing production growth, higher demand and huge API crude inventory declines, is starting to readjust.
Be that as it may, Goldman Sachs (GS) seems to believe oil must fall to $45 by October (like it previously thought $30 oil was a certainty) to clear the market and rebalance, despite signs that a readjustment is already underway. When was the last time fundaments got ignored and prices went in opposite direction? As an aside, take a look at the S&P 500 vs. GDP growth, as one makes new highs while the other falls from 3% growth to under 1% so far this year!
In other words, asset prices continue to be set by central bankers, and not free markets, so the GS call does make sense if you believe fundamentals don’t matter at all. Still, they should be discussed either way. Rather than being based on the fundamentals, GS, like others, have consistently been off the mark when it comes to oil prices, but refuse to acknowledge it (the agenda at GS has been exposed via Zerohedge). Multiple calls just this week for $45, on top of other economic research, clearly reveal this.
I will be first to admit that I thought oil prices short term would peak in $60s and $70s, but I never thought they would retest the lows. Why should they, if all the trends point to markets slowly rebalancing? In fact, there is growing evidence that not only are we slowly rebalancing but the world may actually be running short of oil. According to Reuters, Saudi Arabia has turned down requests from China for more oil, as they are using it for their own domestic refining needs. It goes on to quote: “[a]nother source with a Chinese refinery that takes Saudi oil said Saudi heavy crude was ‘a bit tight’ in May and June.” China was forced to turn to Russia, Oman, and other non-OPEC nations for their needed supply. Why would Saudi Arabia refuse to supply China unless oil was, in fact, tight?
This provides the strongest indication yet that the world is not facing a 2 million barrel-per-day surplus in supply, as many allege, and instead the call on OPEC crude is most likely growing. The latest EIA weekly inventory data showing a drawdown of 2.7 million barrels reaffirms that the U.S. is no longer oversupplied either.
Finally, just to reinforce the point, oil companies indicated during some of their first quarter 2015 earnings calls that rigs could begin to be added back into operation when prices reach somewhere in the neighborhood of $70 per barrel. Quite frankly, producers shoot themselves in the foot by providing a set price, which, I believe, affects how oil is traded. GS and everyone else are using that guidance on trading oil. But to be clear, we know for sure rigs won’t be added at $50, never mind $45. Once you factor in the natural depletion of existing wells, production will have to eventually go down – another reason why the GS call will be wrong.
Leonard Brecken is a portfolio manager and principal at Brecken Capital LLC, a hedge fund focused on domestic equities. You can reach Leonard on Twitter: @Lbrecken13
Originally written for OilPrice.com, a website that focuses on news and analysis on the topics of alternative energy, geopolitics, and oil and gas. OilPrice.com is written for an educated audience that includes investors, fund managers, resource bankers, traders, and energy market professionals around the world.
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