By Nick Cunningham
Oil prices could soon fall below $40 per barrel if there isn’t a sustained drawdown in U.S. crude inventories and rig counts or without bold action from OPEC.
That prediction comes from Goldman Sachs, which says that the oil market is searching for a new equilibrium. The investment bank says that it is still too early to tell whether or not the most recent inventory reductions in the U.S. are an anomaly or the start of something more durable. Moreover, the higher-than-expected inventory declines in June occurred at the same time that Libya and Nigeria were adding new sources of supply. That is why the enormous drawdown, particularly last week, prevented the oil bulls from coming out in full force. Rightly so.
The rig count also initially appeared to be slowing – and actually declined recently for the first time in months – but rebounded in the most recent data. The same was true for U.S. oil production data, which fell and then rebounded. All of this is short-term noise in the data, and it will take several more weeks to see how the shale industry responds to recent plunge in oil prices. Goldman says the “coming month will be key to testing whether producers are responding to the signal of $45/bbl WTI prices.”
The early signs of a slightly tighter market are likely not enough to assuage the fears of oil traders, which have grown wary of trying to position themselves ahead of a theoretical rebound. Because the markets have grown impatient with the pace of market adjustment, Goldman warns that the risk on the downside is imminent. If the shale figures fail to contract in response to the plunge in oil prices, that means prices might have to fall further.
OPEC is set to meet again on July 24 for a compliance meeting, which Goldman says gives the cartel another opportunity to try to fix the imbalances in the market. However, instead of talking up prices with hints and comments about what it might do – a perennial OPEC tactic – Goldman says OPEC should instead pursue a “shock and awe” approach, which is to say, aggressive action without any clues to the public beforehand.
Without that, and without strong drawdowns in crude inventories, oil prices could soon fall below $40 per barrel. That prediction comes roughly two weeks after Goldman downgraded its three-month oil price forecast from $55 to $47.50.
The problem is that the chances of deeper OPEC cuts, at least right now, appear to be slim. OPEC’s Secretary-General said just a few days ago that cuts were not even on the agenda for the meeting. The meeting, after all, is just meant to monitor the compliance of the existing cuts.
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At the same time, there have been hints recently of potential future action. Russia’s energy minister Alexander Novak told CNBC on Monday that OPEC and non-OPEC countries have the option of cutting deeper or extending the cuts, if necessary. Also, OPEC invited officials from Libya and Nigeria to its July monitoring meeting, which could foreshadow the attempt to remove their exemption from the cartel-wide cuts.
However, both Libya and Nigeria will likely resist such a move, and in any event, if the cap is removed, it probably would not take place until the November meeting.
That all suggests that the pressure on oil prices in the short-term will come down to forthcoming data from the EIA, which will demonstrate whether or not the shale rebound will slow with prices below $50 per barrel.
“Given that the market is now out of patience for large stock draws and increasingly concerned about next year’s balances, we believe that price upside will need to be front-end driven, coming from observable near-term physical tightness and signs of a US shale activity slowdown on a sustained basis in coming weeks,” Goldman analysts wrote in their research note. If inventories fail to start declining at a faster rate, or the rig count fails to slow down, WTI prices could soon have a number that begins with a 3.
By Nick Cunningham of Oilprice.com