Part way through the United States subprime mortgage crisis in 2008, Goldman Sachs (NYSE:GS) predicted an oil price surge that would exceed $200 a barrel. Instead, this marked the beginning of a bear cycle for the oil industry, and Goldman’s prediction became known as the kiss of death for the oil price. Today, Goldman is again airing a bullish stance on the outlook for the oil price in 2021 and beyond. But there are many dynamics at work, and investors are once more questioning this prediction.
A fluctuating oil price
In 2008, Goldman analyst Arjun N. Murti predicted $200 oil. He was basing this prediction on a growing addiction to oil. Plus, the belief that supply would stay tight because of geopolitical factors. Back then, famed oilman, T. Boone Pickens, was still alive and also predicting crude at $150.
The oil price did reach $169 that year, but promptly plunged to $52 by 2009. Between 2014 and 2016, it plunged again and when Covid-19 hit in 2020, an accumulation of events led to a spectacular decline that ultimately sent the oil price negative.
Since then, it has recovered to hover around the $60 a barrel range. But Goldman Sachs predicts Brent crude at $75 for Q2 of 2021, and $80 for Q3.
The push into decarbonisation is unprecedented. This is discouraging investment in the sector, which Goldman sees as creating the potential for a supply led bull run. The bullish outlook comes from forecasting an oil ‘supercycle’. To back up its stance, Goldman has identified five themes for change within the oil and gas industry.
1. Shrinking Reserves: The decarbonisation pressure from investors has ultimately stopped investment in oil and gas
2. A change in the cost curve. The shale revolution was widening the cost curve, but Covid-19 has decimated the shale industry, which means higher oil prices may be achievable once more. While some analysts see oil prices reinvigorating shale, many think the higher barriers to entry make this unlikely. And the Biden administration are clearly anti-oil.
3. The end of non-OPEC growth. Shale expansion in recent years and other non-OPEC growth, has been stopped in its tracks. But a sustained period of underinvestment will lead to fewer large oil and gas projects coming onstream.
4. Consolidation. The industry is under tremendous pressure to cut costs and put capital to work efficiently. This will inevitably lead to consolidation, cost cutting and capital efficiency.
5. Higher returns. The pressure to cut costs, will ensure capital efficiency, and capital constraints, which will lead to better returns, and better free cash flow, ultimately leading to a cycle of higher returns.
The higher barriers to entry and tighter financing conditions mean it’s the strong that are most likely to survive. The world’s strongest oil industry veterans have themselves consolidated and changed over the years.
Now, the top eight oil and gas companies are: Royal Dutch Shell(LON: RDSB), Saudi Aramco (TADAWUL: 2222), PetroChina (SHA: 601857), Sinopec (SHA: 600028), BP (NYSE: BP), Total (NYSE: TOT), Chevron (NYSE: CVX), and ExxonMobil (NYSE: XOM).
The slowdown in demand comes with a focus on climate change, which Goldman believes will lead to improved profitability.
But on the flip side it sees the oil services industry as being the most likely to suffer with companies in distress. For those to emerge victorious, they’ll need to grab long-term opportunities through consolidation, improving cost structure and transitioning into becoming energy services companies with a focus on hydrogen, carbon capture, offshore wind, and electric vehicles.
Examples of industry changes are all around us. To illustrate Bloomberg reported Arabian Drilling Co., a Saudi oilfield-services company part-owned by Schlumberger (NYSE: SLB), is preparing an initial public offering (IPO) that could give it a valuation of around $2 billion.
A short history of recent oil price volatility
When the price of oil plummeted spectacularly in April 2020, it was the accumulation of three major events.
Saudi Arabia and Russia were at war over their share of the oil market. Russia refused to slow production in an attempt to keep prices higher. But Saudi Arabia ramped up its production and heavily discounted its supply in response. This along with the worldwide slump in demand for oil caused by the Coronavirus crisis, and with US oil inventories at a record high, all led to the shock of a negative oil price on April 20.
Such a thing had never occurred before, and many didn’t know it was even possible. But the way derivatives trading works in the commodities markets meant paper traders were desperate to get rid of their futures contracts on fear of having to accept the physical oil with nowhere to store it. The shock was short lived but has left fear and uncertainty across the oil industry.
The future oil price
Today, the Brent crude oil price is around $66 and WTI crude is around $63. So, will it climb any higher from here as the world reopens?
While the UK, China and US economies appear to be attempting to reopen, many other parts of the world are still suffering badly from the pandemic. India and Brazil are in a particularly dark place, while Japan and Europe are reeling from further Covid-19 spikes. This puts more uncertainty on the pace of demand for oil resuming.
Then there’s The Organization of the Petroleum Exporting Countries (OPEC) increasing production without altering its demand forecast. It currently sees demand for the second half of 2021 reaching 5.95 million barrels per day.
Goldman remains optimistic that the aviation recovery and rising electricity demand in the Middle East, which are directly linked to crude-fired power generators, will boost oil prices throughout the year. It recently declared it expects the biggest jump in oil demand ever, thanks to successful vaccine rollouts and rising travel demand.
But consensus is not building on this outlook. A prestigious group of experts at the Oxford Institute for Energy Studies (OIES), does not see the oil price reaching $100 a barrel soon. And Saudi Energy Minister Prince Abdul Aziz bin Salman, agrees.
Bassam Fattouh and Andreas Economou of the OIES, argue:
“Some key triggers of an oil supercycle, such as an inelastic supply in the face of rampant demand and lack of spare capacity and refining constraints, which could push prices to $100 a barrel and keep them at those high levels, are still missing… Rather, oil will trade in a range of $59-$69 per barrel until the end of 2022,”
Iranian elections are another area of concern. When Trump was in power, sanctions were brought against Iran and relations soured. But if a nuclear deal is made between Tehran and Washington, there is concern Iran will be allowed to produce oil again and thus flood the market. The OIES believe this concern is overstated.
Furthermore, if the Indian Covid-19 situation continues to escalate, then oil demand from that part of the world is going to take longer to resume. And in response, the Middle East is likely to ramp up its production. This will be even more likely if Iran gets permission to produce.
The oil price has suffered extreme crashes in 1983, 1986, 1999, 2001, 2008 and 2020. After the shock of negative oil last year, it seems OPEC+ is becoming more subtle in its moves, making it harder to predict what it will do next.
As John Maynard Keynes famously said, ‘the markets can remain irrational longer than you can remain solvent’. So, where the oil price will go from here is ultimately in the lap of the gods.