Energy forecasters see a worsening supply glut in 2020, putting OPEC+ in a bind. But beyond that, the bust could result in a boom as supply growth slows to a trickle.
“For three years, oversupply has deteriorated Energy equity sentiment,” Goldman Sachs wrote in a note on Monday. That presented an impossible choice for OPEC – cut output or let prices crash? The group chose to slash production in an effort to rescue prices, but in doing so, it arguably prolonged the adjustment by propping up unprofitable shale drillers.
OPEC faces the same choice as it approaches its December meeting, and the prospect of another year of oversupply looms.
However, U.S. shale is indeed slowing down. Theoretically, as shale drillers bite the dust in increasing numbers and rigs continue to get scrapped, the slowdown will help the market rebalance, which could lead to a more durable price rally.
“We believe this inflection may be around a year away,” Goldman Sachs wrote.
The investment bank says that slowing U.S. shale production growth combined with a shortage of investment in long-term projects will lead to a new boom. Goldman lowered its forecast for U.S. oil production growth to 0.7 million barrels per day (mb/d) in 2020, down sharply from its 1 mb/d forecast previously. Interestingly, Goldman attributed the downward revision not just to a slowdown in drilling, but also to “updated longer-term decline rates to be consistent with play-to-date results,” which is a complicated way of saying shale wells are not performing as well as previously anticipated.
Some shale drillers will engage in high-grading, or drilling in the best spots, which provides a “temporary productivity boost in 2020,” the bank said. But “initial 2019 productivity data suggests that shale productivity improvements appear to be decelerating across key US oil shale plays and deteriorating in the Eagle Ford Shale.”
The analysts added that “oil decline rates “may have increased somewhat relative to earlier years of shale.” What does all of this mean? A peak in productivity gains “may be only a year away.” That doesn’t mean an outright decline in output is imminent, but drillers may have to pump much more money into the ground to extract a barrel of oil than previously thought.
Weaker supply growth from U.S. shale also coincides with a slowdown in supply additions from large-scale projects. “The last wave of 2014/15-sanctioned long lead time projects will be ramped up in the next 6-9 months,” Goldman said. The oil price crash that began in 2014 led to severe declines in investment in long-term megaprojects. Ultra-deepwater, Canadian oil sands, and other massive and complex oil projects were off the table in a market that saw Brent crude drop by more than half.
Because those projects take years to come online, we are only now reaching the end of the pre-2014 project pipeline.
In the short run, oil prices are languishing below $60 per barrel, and Goldman Sachs says that little will change. “[A]bsent growth or geopolitical tensions escalating into meaningful shocks, we expect that Brent oil prices are likely to continue trading in 2020 around our $60/bbl forecast,” the investment bank wrote in a separate report published on October 22.
However, in a year or so, Goldman sees the market hitting that inflection point, at which point OPEC+ faces a set of decisions as prices start to rise. OPEC+ could gradually raise production, easing output back online and keeping prices at around $60 per barrel. It could also choose not to raise production, pushing up prices. Finally, in an undersupplied market, OPEC may need to raise output by a more significant degree, but prices still rise and OPEC runs low on spare capacity.
It’s not clear how instructive these three scenarios are since they cover a wide range of outcomes (i.e., oil prices could stay low, or they could go up!), but the notion that the market could reach an inflection point in a year is an interesting one. If it comes to pass, it would mark the end of a downturn that lasted more than half of a decade.