Goldman Turns Significantly Bearish

Jim Brown
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Back in 2008 Goldman made a market call saying crude oil would rise to $200. Prices surged in the days after the call but stopped at $150 before crashing back to $40 during the financial crisis. Now they are predicting $50 oil in 2020. You have to wonder what these guys are smoking and why anyone listens to them.

Back in July 2014 the company said the "long awaited global recovery is on track and commodity demand is rising." A couple weeks later oil prices began to crash from $106 to $42 in March. Conspiracy theorists believe Goldman loads up its positions in the weeks ahead of a market call and then dumps on the market in the direction that is most beneficial to Goldman. This time around it did not work.

Goldman said last week that they are expecting WTI prices to average $52 for 2015 an rise to average only $60 by 2017 before falling back to $50 in 2020.

Goldman said they weighted the historical price of oil, natural gas and something they are calling the shale efficiency ratio to produce their five-year outlook. They said the only gains in the energy sector will come from M&A as the bigger players gobble up the debt distressed smaller players.

They are predicting short-term WTI prices in the $55 range that will only allow a few shale producers to be profitable. The others are going to see decreasing cash flow as existing wells deplete and they can't drill new wells because they are not profitable at $55.

With the average cost per barrel in the shale fields from $35 to $71 depending on the field and the well locations in that field the only locations that are going to be profitable over the next year are the best spots in the core of the field. Anything on the fringes of the play will not be drilled.

The smaller and undercapitalized players did not win leases in the core. They had to settle for the fringe areas at lower prices. To use a golf analogy on any hole there is the rough, fairway and the green. The green represents the core of the play where you have the most productive wells. The fairway is the stretch around and approaching the green and the rough is the high grass area that may or may not be productive.

Those players with leases on the green will continue to be profitable. Those with leases on the fairway could be marginal from well to well depending on whether they accidentally hit a sweet spot. Those well locations in the rough will not get drilled.

Companies like EOG Resources, Continental Resources, Whiting Petroleum, Anadarko, etc have prime drilling locations on the green. Everyone else is wandering around in the rough trying to find a decent location to bet on with their remaining capital.

Goldman said the rebound in oil prices from $42 to $60 was too quick and did not allow for the rebalancing in drilling and production to be completed. "Prices need to sequentially weaken, to resume the oil market rebalancing as well as help correct the still intact imbalance of too much capital looking for opportunities in the energy space."

They warned that the 50% decline in active rigs was not enough to put production on a "persistent downward trend." Active rigs have declined for 24 consecutive weeks. "This may delay the sequential decline in prices until this fall." Goldman expects production from non-OPEC countries to decline by -200,000 bpd in 2015. Since the U.S. production is already -178,000 bpd off its March peak that forecast may be a little weak.

In opposition to the Goldman forecast Michael Wittner, global head of oil research at Societe Generale, said the chance of another sharp decline in oil is rapidly declining. "The window for a correction will be closing over the next several weeks." He based his forecast on the high demand summer season and the coming decline in oil inventories. Many other analysts are predicting a return to $70 by the end of 2015.

Merrill Lynch upgraded the energy sector to overweight in opposition to Goldman's bearish call. They said the timing "looks solid" and investors that avoided catching the falling knife and waited until the upturn in prices was well underway would be well rewarded. Merrill is convinced the bottom is behind us and that sentiment and valuations are at 30 year lows.

Merrill favors "big, old and ugly" energy stocks. They have shown long term staying power and pay outstanding dividends. Conoco, Exxon, Hess and Occidental Petroleum headed the list of Merrill recommendations.

Only two more weeks until OPEC meets on June 5th to discuss production quotas. No change is expected since everyone is already producing as much as possible. With some countries bleeding cash because of the low prices there will be a battle but whatever Saudi Arabia wants is what will happen.

Active Rigs

Active drilling rigs declined -3 to 885 for the week ended on Friday. Oil rigs declined -1 for the week to 659. Active gas rigs fell 01 to 222. Active rigs have now declined -1,040 since the high of 1,931 in September. That is a -59% drop. Active offshore rigs dropped sharply by -5 to 29 and well off their January high of 60.

Oil Inventories

Crude inventories declined -2.7 million barrels to 482.2 million and the third decline in the last 20 weeks.

Refinery utilization rose to 92.4% last week from 91.2%. Imports rose +320,000 bpd. U.S. production fell -112,000 barrels to 9.262 mbpd. That is -178,000 bpd off the peak of 9.44 mbpd on March 27th.

Cushing inventories declined slightly to 60.4 million. Oil in storage at Cushing will not begin to decline until the next futures cycle. Speculators that bought oil and stored it at Cushing while selling into a longer dated futures contract will "deliver" that oil when their contract expires. That could be next month or several months from now. Meanwhile Cushing has no available storage for future speculation.

EIA Crude Inventory Chart

Gasoline inventories declined -2.8 million barrels to 223.9 million. Gasoline demand rose +60,000 bpd and imports fell -234,000 bpd.

Distillate inventories fell -.5 million barrels to 127.7 million. Demand fell sharply by -363,000 bpd. Imports declined -67,000 bpd.

In the graphic below green represents a recent high and yellow a recent low.

Jim Brown

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