• Goldman’s global head of Commodities Research Jeff Currie gives his take on this week’s turmoil in the oil market.
• The coronavirus and oil price war between Saudi and Russia are not two new separate things, the price war can instead be thought of as a second-round effect of the virus.
• Saudi most likely opted to cut prices now because; 1) balance sheets of US oil producers are already damaged by demand weakness related to the coronavirus making it now easier to hurt producers 2) US sanctions on have had a substantial impact on Russia (Nordstream and Rosneft), particularly for gas. 3) Russia did not like the ultimatum Saudi imposed with the hoped-for production cut.
• Currie view this not as a price war, instead it’s more a market share strategy.
• Energy stocks have now lost nearly two decades in gains and investors are asking when they should buy. Currie thinks it’s too early on oil (given negative carry) but energy stocks have high dividends to protect from further downside.
• Goldman sees this as a new oil order, low cost producers have an economic incentive to increase production to gain market share.
• In contrast, the economics of a production cut do not make sense. Shareholders have paid the price for earlier production cuts.
• Goldman sees $30/b on Brent for the coming quarters then rising steadily from Q4, reaching $55 by Q4 next year. Inventory build-up in Q2 and Q3 keep prices subdued but as this starts to decline prices start to recover.
• Energy markets go through three phases; survival, inflection, regeneration. We saw the survival phase in 2014. Current inflection phase expected from Q4 and will see the most volatility in prices and a flattening of curve in this period. Then we move to regeneration phase with needed restructuring.
• What’s different this time is that the rebalancing / regeneration phase after the 2014 price decline was stopped short due to stimulus from China, OPEC production cuts and fiscal stimulus in US. Markets failed to rebalance and too much capital remained in the sector.
• Economics behind market share strategy are sounder than economics of production cuts. Any agreement to limit production is therefore not necessarily bullish.
• Oil market is witnessing a structural shift. A price war is easier to win in a weak demand environment and rebalancing is inevitable.
Why does this matter? Investment spending will be sharply curtailed, and bankruptcies and job losses are increasingly likely in shale with breakeven prices generally much higher than spot. This will offset the positives from a lower oil price for US consumers. While the impact will be concentrated in a few US states rising defaults by highly-leveraged shale companies could lead to wider stress in the US credit market.
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