Analysts at Goldman Sachs remain confident that the second quarter of 2017 will bring consistent inventory declines, and warn that global demand growth may top its already ambitious 1.5 million-b/d-year target. The bank also reiterated its view that front-month WTI will rally to a high of $57.50 bbl before July arrives.
But unlike many other banks, investment houses and hedge funds, the brain trust at Goldman does not talk of $60-bbl, or $70-bbl or even $80-bbl oil benchmarks. The Goldman view is that the long-term appropriate price for WTI is about $50 bbl, or under the $53 bbl or so levels witnessed in recent sessions.
The company stresses that commodities, and particularly oil, represent a smart investment this year. But that view is rooted not so much in price, but rather in structure. Notwithstanding U.S. inventory builds that clearly surprised to the upside through March, bank analysts believe that the draws are coming, and tighter near-term supply will lead to a steep level of backwardation later in 2017.
Investments in oil funds, which typically roll forward positions month after month as benchmarks expire, get punished when oil is in contango, which has prevailed since mid-2014. On the other hand, a backwardated futures' structure rewards investors who see their holdings swell in that environment.
(OPIS provides an example: A $1 million position in an oil ETF at $53 bbl would reflect 18.87 contracts. If the next month were say 30cts bbl lower, that $1 million roll to the next month would result in 19.05 contracts. Volume holdings would continue to expand if the market remained backwardated.)
In a commodities report that amounts to a tutorial on the asset class, Goldman analysts note that if oil is priced higher ahead of anticipated inventory draws, sellers would simply dump inventory from storage and crush spot prices, putting the market back into contango. Investors need to differentiate between financial markets that are "anticipatory assets" and commodities and physical markets that represent "spot assets."
Despite the $57.50 bbl spring target, the bank has expectations well below those of its peers for the longer 10-year time frame. Its base case assumes that $50 bbl is a fair price for WTI over the long term, and it mentions aggressive hedging programs as a threat to further downside. Spot prices need only be above the long-term cost of producing shale -- the marginal barrel these days -- to incentivize investment.
Goldman suggests that the last time oil futures had a level of certainty comparable to now was back in 2003, before the record spikes of the last decade. Sovereign producers could plan around a $20-bbl price and didn't have to save or borrow large amounts of U.S. dollars. The bank believes that the global oil industry is returning to an environment akin to the period preceding 2003, when there was stability in long-term oil prices and a very low oil-to-dollar correlation.
In the end, Goldman analysts believe strong commodity returns this year will be linked to backwardation and not appreciation. That makes the period reminiscent of the 1990s, when commodity returns were generated from carry and not from price hikes.
Some other observations from the bank today:
--Goldman analysts still believe that it's not in OPEC's best interest to extend production cuts. That would simply provide more incentive for additional drilling.
--Markets appear to have lost confidence in the Trump administration's ability to implement policy, and the only real faith is in deregulation that can be accomplished without congressional approval. But the bank still sees an uptick in infrastructure spending.
--Notwithstanding the slow start in 2017, Goldman thinks gasoline demand will pick up and it forecasts 70,000 b/d growth, which would imply a new record for consumption.
--Diesel inventories are normalizing fast and signs point to global demand rising with accelerating industrial activity.
--On a day that featured EIA measuring refinery runs, some 738,000 b/d above the same period in 2016, Goldman suggested that refinery runs would eventually average less than 2016. It also suspects that disruptions in Mexican refining could potentially boost RBOB and other U.S. grades of gas.