Goldman Sachs Research
Oil Analyst
A Pessimistic Oil Market
6 May 2023 | 12:37PM EDT | Research | Commodities| By Daan Struyven and others
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  • Following the 15% selloff in oil prices over the last 3 weeks, forward prices now look unusually low relative to consensus and our own forecasts. We analyze the selloff, the implications of the large gap between consensus expectations and forwards, and the risks to our unchanged constructive Brent forecast.

  • We argue that near-term demand fears—related to US banking stress, China industrial weakness, and falling diesel margins—and financial amplification effects have driven the bulk of the recent selloff. Headlines about elevated oil supply in Russia and Iran, and fears of limited OPEC compliance to cuts have likely weighed on oil prices too, though we see these concerns as overblown. Statistically, we find that US banking stress and the OPEC cut together explain much of the daily price action over the last couple of months.

  • Today’s 29% gap between 12-months ahead Brent consensus expectations and the forwards ranks in the 98rd percentile vs. history. We find that future spot prices tend to end up significantly above forwards-implied levels when the consensus is above the forwards. A model using today’s gap suggests that spot prices in 12 months will end up 16% above today’s 12-month forwards outside a US recession, but 4% below in recession.

  • Our forecast remains that Brent rises to $95/bbl by December and $100/bbl by April 2024 as we expect large deficits in H2. While above-average DM recession risk and our China oil demand nowcast point to downside risk, we still expect rising EM demand to drive ¾ of the swing from the Q1 surplus to H2 deficits averaging 1½mb/d. The risks to our view that global supply edges down in H2 are two-sided with upside risks from Russia and Iran, but downside risks from potential additional OPEC cuts in H2 if oil prices were to not rise from here.

The Large Gap Between Consensus Expectations and Forwards Points to a Pessimistic Market Pricing Several Downside Risks

The Large Gap Between Consensus Expectations and Forwards Points to a Pessimistic Market Pricing Several Downside Risks. Data available on request.
Source: Bloomberg, Goldman Sachs Global Investment Research

A Pessimistic Oil Market

Although Brent oil prices recovered modestly on Friday to $75/bbl, they remain 15% lower than 3 weeks ago. Forward prices now look unusually low compared to analysts’ consensus expectations that Brent spot prices will recover to $90/bbl in 12 months, and to our own $100/bbl forecast (Exhibit 1). We analyze the drivers of selloff, the implications of this large gap between consensus expectations and forwards, and the downside risks to our unchanged constructive Brent forecast.

Exhibit 1: Oil Forwards Now Look Unusually Low Compared to Consensus Expectations

1. Oil Forwards Now Look Unusually Low Compared to Consensus Expectations. Data available on request.
Source: Bloomberg, Goldman Sachs Global Investment Research

A Mostly Macro-Financial Selloff

We argue that the sharp selloff over the past 3 weeks reflects: (1) mostly recessionary fears about demand, (2) financial amplification effects, and (3) headlines about elevated oil supply in Russia, Iran, and other OPEC countries.
The substantial weakening in near-dated timespreads, our statistical analysis, and conversations with investors all suggest that near-term recessionary fears have driven much of the recent selloff.
The sharpest oil price drops have coincided with rising fears that regional banking stress will push the US in recession. Statistically, we find that US banking stress—proxied using US bank equity prices—and the OPEC cut announcement together explain much of the daily Brent price action over the last couple of months (Exhibit 2).[1] In addition to US banking stress and US debt ceiling risks, weakness in Chinese industrial data, and falling distillate cracks are also fueling concerns about demand (Exhibit 3).

Exhibit 2: Rising Concerns About US Banks and Falling Oil Prices

2. Rising Concerns About US Banks and Falling Oil Prices. Data available on request.
Source: Bloomberg, Haver Analytics, Goldman Sachs Global Investment Research

Exhibit 3: Demand Concerns on Weak China Manufacturing Data and Falling Distillate Cracks

3. Demand Concerns on Weak China Manufacturing Data and Falling Distillate Cracks. Data available on request.
Source: Bloomberg, Haver Analytics, Goldman Sachs Global Investment Research
We don’t think that US regional banking stress, weak China industrial data, and falling distillate cracks are harbingers for contractions in GDP or global oil demand.
Our economists see only a ¼ – ½pp growth hit from bank stress as large banks remain healthy, and Friday’s data confirmed US job growth remains strong. While global industrial activity is weak, the PMIs also suggest that services activity is still expanding very rapidly in China and fairly rapidly elsewhere. Finally, we estimate that c.2/3 of the $25/bbl sell-off in European distillate cracks since January reflects factors other than demand, including 1) excessively high prices ahead of the EU Russian product embargo, 2) significant refining additions, and 3) lower-than-expected gas prices and clean tanker freight rates.
We also believe that low liquidity, the interaction of negative gamma effects in options markets and banking-stress[2], and trend-following algorithms have amplified the downward price pressure from selling by investors expecting recession. Liquidity was low at the start of last week following holidays in Asia and Europe, and the exodus of several bullish speculators following challenging recent performance.
While outsized responses to macro fears explain the bulk of the selloff, headlines about elevated oil supply in Russia and Iran, and fears about limited OPEC compliance have likely weighed on oil prices too, though we see these concerns as overblown.
As Exhibit 4 shows, our nowcast suggests that Russia produced around 11.1mb/d of total liquids in April, about 400k/d above our forecast that Russia would fully implement its pledge to cut production by 500kb/d from February levels. While markets appear focused on the salient rise in seaborne crude exports, especially to India, refinery runs and pipeline exports have fallen since February.
We, do, however suspect our nowcast overstates actual Russia production for three reasons. First, industry-level data reported by Bloomberg suggest that refinery runs have now declined by around 200kb/d more than implied by our Petrologistics and IIR data due to seasonal maintenance. Second, Bloomberg has also reported a rise in the share of idled and shut-in wells to 18.1% in March, a record high since May 2022. Third, Russia may be shipping oil from underground storage which our measures of stocks in refineries and ports don’t capture.

Exhibit 4: While Our Nowcast Offers No Evidence of Russia Production Cuts; We Suspect That Actual Production Has Fallen

4. While Our Nowcast Offers No Evidence of Russia Production Cuts; We Suspect That Actual Production Has Fallen. Data available on request.
We do not display NGLs on the chart as there were no changes in our assumed NGL production over the period.
Source: Petro-Logistics, Kpler, Industrial Info Resources, IEA, Goldman Sachs Global Investment Research
Turning to Iran, its oil minister said on Tuesday that crude oil production has reached above 3mb/d per day over the last 20 months, 250kd/above our standing 2.75mb/d forecast. Our estimation using seaborne exports suggests production jumped late last year, and has now moderated to 2.85mb/d, implying some upside risk.
Finally, a pick-up in gross exports by core OPEC countries in March and April has led to fears of limited compliance to production cuts. However, the more stable level of net exports—reflecting the large rise in imports of cheaper Russian oil—supports our view that OPEC producers will largely implement the voluntary cuts announced in April.

Mind the Gap

Following this mostly macro-financial driven selloff, forward prices now look unusually low compared to analysts’ consensus expectations (Exhibit 1). In fact, today’s 29% gap between 12-months ahead Brent consensus expectations (90$/bbl) and the forwards (70$/bbl) ranks in the 98rd percentile vs. history. What tends to happen to spot prices historically when the consensus is much more optimistic than the forwards?
To find out, we regress the gap between realized spot prices 12 months ahead and the forwards on the gap between 12-months ahead consensus expectations and the forwards. We express both gaps as % of the forwards, and include a constant.[3] To be clear, we don’t assume that forwards are unbiased predictors of expected future spot prices.[4] Instead, we ask whether large gaps between consensus and the forwards predict larger-than-usual gaps between future spot prices and the forwards.
We find that, on average[5]:

  1. Spot prices realize 4% above the consensus, and 7% above the 12-month forwards, consistent with a positive risk premium.

  2. Spot prices end up significantly above forwards-implied levels when the consensus is above the forwards. Specifically, every 10% gap between the consensus and the forwards implies an additional 3% outperformance of spot versus the forwards (on top of the 6% outperformance when consensus and forwards are in line).

  3. The predictive content of the consensus diminishes as the forecast horizon shortens, and disappears when the US economy ends up in recession.

What are the implications of this simple model for today’s outlook? The model suggests that spot prices in May 2023 will end up 16% above today’s 12-month forwards outside a US recession at 81$/bbl, but only 4% below at 67$/bbl in case of recession (Exhibit 5).

Exhibit 5: Today’s Large Gap Between Consensus and the Forwards Suggests Spot Prices Will Likely End Up Well Above the Forwards

5. Today’s Large Gap Between Consensus and the Forwards Suggests Spot Prices Will Likely End Up Well Above the Forwards. Data available on request.
Source: Bloomberg, Haver Analytics, Goldman Sachs Global Investment Research

Some Downside Risks

We conclude by discussing why we and the consensus are more constructive on the price outlook than the forwards, and discussing the risks to our forecast that Brent rises to $95/bbl by December and $100/bbl by April 2024.
The main driver of our constructive forecast is the expected return to large and sustained deficits from June onwards, leading to inventory draws, and firming timespreads. As Exhibit 6 shows, we expect large deficits averaging 1.5mb/d in H2, and the IEA expects an even larger deficit averaging 2.0mb/d.

Exhibit 6: We Expect Deficits to Average 1.5mb/d in H2

6. We Expect Deficits to Average 1.5mb/d in H2. Data available on request.
Source: IEA, Goldman Sachs Global Investment Research
Further rises in EM demand and OPEC cuts are the two key pillars behind our call for H2 deficits.
We expect rising EM demand to drive ¾ of the 2mb/d swing from a moderate surplus in Q1 to sizable deficits in H2. Although our China oil demand nowcast of 15.8mb/d is modestly below our 16mb/d April forecast, we expect China oil demand to rise further. The key reasons include strong May services PMIs and travel data, substantial remaining room for growth in the services sector—especially for international travel—, and policymakers’ emphasis on the importance of services consumption such as tourism (Exhibit 7).
We also continue expect a nearly 90% implementation rate for the 1.16mb/d announced cut to OPEC+ ex Russia production. The reason is that the countries which announced an additional cut have a strong compliance track record, and had implemented nearly 90% of the October 2022 cut by January 2023.

Exhibit 7: Room for Growth in International Travel and Jet Fuel Demand

7. Room for Growth in International Travel and Jet Fuel Demand. Data available on request.
Source: ICIS, OilChem, OAG, Jodi, IEA, Bloomberg, Kpler, Goldman Sachs Global Investment Research
We next quantify the four main sources of downside risk to our December $95/bbl forecast:

  • Moderate OECD-centric recession (-$10/bbl): This scenario assumes a moderate OECD recession starting in 2023Q3, lasting 4 quarters. It assumes a peak 4% hit to the level of GDP (relative to the GS baseline), which is slightly more moderate than the median historical recession in G10 economies, and modest spillovers to non-OECD economies. While the eventual hit to 2024Q2 prices relative to our baseline is sizable at -$22/bbl, the hit implied by our demand and pricing models to December 2023 prices is much smaller at just $10/bbl. The key reason is that spot oil markets generally price the near-term outlook for inventories, which only reach high levels after multiple quarters of demand damage. Exhibit 8 also suggests that oil markets are pricing an even more negative GDP outlook than this moderate recession (assuming the market shares our views on supply).

Exhibit 8: A Moderate OECD-Centric Recession Would Lower Brent Prices Eventually by $22/bbl

8. A Moderate OECD-Centric Recession Would Lower Brent Prices Eventually by $22/bbl. Data available on request.
Source: Haver Analytics, Goldman Sachs Global Investment Research

  • Persistent China demand miss (-$3/bbl): This scenario assumes that the 250kb/d miss on our China April demand forecast implied by the nowcast monthly average persists, and implies $3/bbl of downside risk to our December 2023 forecast.

  • No Russia supply cuts (-$6/bbl): This scenario assumes that Russia keeps total liquids production flat at its February level of 11.2mb/d, and implies $6/bbl of downside risk. Our central assumption remains that Russia cuts production, largely in the context of OPEC+ coordination.

  • Higher Iran supply (-$3/bbl): This scenario assumes that Iran production exceeds our forecast by $250kb/d from March onwards, and implies $3/bbl of downside risk.

Taken together, our analysis suggests that the forwards are broadly consistent with the market pricing in all these four downside risk scenarios together (assuming the market has the same view on the rest of the balances), without any additional OPEC cut. That seems too pessimistic too us.

Exhibit 9: Some Downside Risk To Our Constructive Brent Forecast

9. Some Downside Risk To Our Constructive Brent Forecast. Data available on request.
Source: Goldman Sachs Global Investment Research
While the market appears too pessimistic, above-average OECD recession risk does skew the risks to our demand assumptions to the downside, on net. The risks to our view that global supply edges down in H2 are two-sided with upside risks from Russia and Iran, but downside risks from potential additional OPEC cuts in H2, and any potential geopolitical disruptions.
We suspect that OPEC likely first wants to observe the impact of its fresh production cuts over the next couple of months, including at the June 4th Joint Ministerial Monitoring Committee (JMMC). However, elevated OPEC pricing power should allow the group to deliver broader or additional cuts if oil prices were to remain around or below current levels in H2.

Daan Struyven

Romain Langlois

  1. 1 ^ We see some analogies with the tug of war in 2010-2012 between relatively tight fundamentals and European recession risk, where fundamentals eventually prevailed.
  2. 2 ^ Negative gamma effects are amplification effects resulting from producer hedging flows. Hedging often takes the form of put options, where market-making banks are short puts (i.e. long oil), and delta-hedge their exposure via futures. As prices fall, the put options move more in-the-money, leaving banks under-hedged unless they sell more futures. This leads to increasing selling of futures as prices decline, reinforcing the selloff.
  3. 3 ^ Our sample consists of weekly data from June 2006 to April 2023.
  4. 4 ^ In principle, expected future spot prices should equal the forwards plus the positive risk premium because oil demand and oil prices co-vary positively with the overall economy. Intuitively, holding oil entails risk, and, as a reward for that risk, investors will expect the spot price to rise above the current forward price.
  5. 5 ^ We also find that, on average, spot prices are modestly above the forwards, consistent with a positive marginal convenience yield (net of storage), and the need to incentivize production (rather than sitting on in-ground reserves which is equivalent to owning a call option with an exercise price equal to the extraction cost and the payoff equal to the spot price).

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daan.struyven@gs.com
Goldman Sachs & Co. LLC
Romain Langlois
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