Goldman: OPEC Should Not Extend Production Cuts
On Sunday, OPEC and non-OPEC producers got together and discussed some things.
Specifically, how the supply cuts are going (i.e. who’s cheating and who’s not and by how much) and whether it makes sense to extend those cuts given the fact that soaring US production and record US stockpiles have created a decidedly bearish fundamental backdrop. For those who missed it, you can read everything you need to know about the meeting here.
Well, as regular readers are aware, Wall Street is pretty wedded to the bullish oil thesis and to the general idea that this market is going to balance, record US production or no record US production. We’re obviously skeptical.
On Monday, Goldman is out with its take on yesterday’s pow wow in Kuwait, and the banks’ analysts now say a “data-dependent” OPEC doesn’t need to extend the cuts in order for the market to balance. In other words, “nothing to see here” with record US production and inventories as “demand pull” will eventually carry the day, giving OPEC some optionality in terms of opening up the spigots without causing prices to plunge back to a 20-handle.
Via Goldman
Incidentally, this seems like an opportune time to recall our post from last week regarding the deflationary dynamic in crude and the interplay between shale, OPEC, and the cost curve.
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We’ve written exhaustively about the deflationary dynamic that grips crude markets.
Indeed, what you’re seeing from US producers is effectively what happens when QE and central banks inadvertently create deflation as opposed to inflation.
It’s very simple, really. The central bank-inspired hunt for yield drives investors down the quality ladder, creating artificial demand for HY debt and equity follow-ons. This relentless appetite for anything that offers investors some semblance of yield allowed otherwise insolvent US production to remain online as operators tapped capital markets to plug funding gaps. Here’s how Citi put it way back in 2015:
Easy access to capital was the essential “fuel” of the shale revolution. But too much capital led to too much oil production, and prices crashed. The shale sector is now being financially stress-tested, exposing shale’s dirty secret: many shale producers depend on capital market injections to fund ongoing activity because they have thus far greatly outspent cash flow.
Capital markets remained open to many of these operators during the OPEC-engineered price downturn, allowing US production to effectively go into hibernation (as opposed to going clean out of business) until prices rose again. Now, they’re back pumping, sowing the seeds of their own demise by offsetting the very OPEC production cuts that allowed them to start pumping again in the first place. This is a circular, deflationary dynamic that can only be short-circuited by capital markets finally slamming shut on US operators and as we saw with the $6.64 billion US energy companies raised in 13 equity offerings in January, that doesn’t look like it’s imminent.
Well, speaking of oil and circular, deflationary deathtraps, Goldman is out Tuesday with an expansive new piece on crude and more specifically on OPEC. We’ll get to the details later, but for now, consider Goldman’s take on how shale has “transformed the cost curve” creating a “structural deflationary cycle.”
Via Goldman
Short-cycle shale has tran
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