Nymex crude crashed to a low of $26.19 last week on the expiry of the January futures contract.
The price has since rallied more than 20% back above $32 but analysts at Goldman Sachs say the crash means “we are now at a price level that is creating real fundamental change,” in the oil market.
Jeffrey Currie, Damien Courvalin, Michael Hinds and Abhisek Banerjee wrote in a note to clients that even though the “market perception” is that it is “demand fears” driving the oil price, it’s their view “recent price declines are not demand driven but rather driven by structural supply forces that have created violent moves to the downside as the market enters the inflection phase to create a path towards a new equilibrium.”
Rather, they say (our emphasis):
The oil market is simply not pricing like a demand-driven bear market. Timespreads in Brent and oil products have strengthened, not weakened, and weakening timespreads are characteristic of demand-driven price declines. Further, some end-use oil product timespreads have tightened more quickly than crude oil timepreads. Demand weakness would have generated the opposite result, and refining margins also remain far above recessionary levels, with some product margins like gasoline actually strengthening on both a relative and absolute basis.
That’s the positive news for the future.
Likewise Currie and his colleagues highlight that fears over Chinese demand are overblown.
“The oil market shows a slowdown in growth in oil demand (3.4% yoy growth as of November), but not an outright collapse. In addition, the rotation away from ‘capex’ commodities used to build infrastructure towards ‘opex’ commodities used in domestic consumption is equally apparent in the composition of oil demand,” they wrote.
Returning to the supply side of the market, Currie says that despite the return of Iran having been “priced into the market before the official announcement”, in reality, Iran simply “underscores how significant the structural shifts in supply have been and how large and deep the required adjustments in higher-cost supply are going to need to be”.
“The starting point for global rebalancing is a very oversupplied 4Q15 which we estimate weather adjusted at 1.2 million b/d,” the bank said.
Which is why the move below $30, and into the lower half of what Goldman believes is a $20-$40 zone that will drive industry adjustment, is crucial.
“We have been focused since last year on two pricing points: financial stress at $40/bbl (credit default level) and operational stress at $20/bbl (well-head cash costs),” the authors wrote.
That stress is showing.
The authors note, “oil markets also witnessed a significant weakening in well-head prices across the US as logistical constraints begin to bind.” That is, the US ability to store more unwanted inventory is drying up as storage facilities are filled.
“We use the term financial stress to refer to adjustments forced on the market by a lack of capital availability. From a financial perspective, this week we observed several large companies outside of the US report production guidance that showed material declines in 2016 oil supplies,” the authors highlighted.
So it appears lower prices are going to eventually see well-heads shuttered, supply reduced and in the end, sow the seeds for an eventual bottom to be found in the price of crude.
But, that said, it’s clear Currie and his colleagues are not backing away from their forecast for lower oil. Nor are they suggesting the worst is over for oil producers or prices.
Rather, they say “we continue to believe this transitional inflection phase is likely to last beyond 1H16 and will be characterized by a trendless market with substantial price volatility potentially between the two stress points of $20/bbl and $40/bbl.”