Goldman Sachs and the unrecognised energy crisis

There is a lot to look at in a new note from Goldman Sachs’ commodities team: a WTI price target of $85 for the end of 2009; a forecast that we are now in the beginning of a four-part bull rally.

More interestingly, the note talks about the ‘unrecognised energy crisis’ and concludes that underlying demand must fall in the OECD countries if the BRICs are to maintain their growth.

But first, the current environment: The $65+ rally under way now, they say, is a normalisation of “pricing dislocations caused by the credit crisis”.

And it won’t stop there: They see the current rally as the first of four over a two-year period – the result of a shifting interaction between inventories, investment levels, Opec production and the macro-economic environment. The next three rallies, they say, will be:

2009H2: A cyclical bull market as the economy stabilizes and OPEC
maintains cuts to draw inventories to 10-year average levels. We are
raising our end of 2009 WTI price forecast to $85/bbl from $65/bbl
.

Interestingly they say most of the fall in demand for oil in 2009 (2.6m/3 per cent, as per the IEA forecast) has already occurred. Opec, they say, holds the key to the second half of this year – but Saudi Arabia at least looks likely to maintain reduced production levels.

2010H1: A structural bull market as long-dated prices rise to motivate
renewed Non-OPEC production capacity investment while OPEC spare
capacity returns to the market in an attempt to bridge the gap. We are
raising our 12-month WTI price target to
$90/bbl from $70/bbl.

“..Thus, we view expected OPEC production increases likely later this year [2009] and into 2010 as nothing more than buying the market some time and helping build an inventory cushion that the market will eventually sorely need given Non-OPEC production declines.”

So, then:

2010H2: A likely return to energy shortages as dwindling OPEC spare
capacity is likely unable to meet rising demand as Non-OPEC production
growth is restricted by limited investment in oil production infrastructure.
We are introducing an end 2010 WTI price forecast of $95/bbl.

So what about these energy shortages? Further along in the note, they expand on this (emphasis ours):

For the past three years, the macroeconomic environment has been dominated by two
recurring themes that have constrained economic growth: the financial crisis and the
energy crisis. Although the financial crisis has been recognized, the energy crisis has not, as the deepening of the financial crisis did not allow oil prices to remain high enough for long enough to generate a solution to the energy problem, which has not gone away. Before last September, the macro economy simply shifted focus between each ongoing crisis: oil prices spike to $75/bbl, sub-prime crisis, spike to $100/bbl, the collapse of Bear Stearns, oil price spike to $150/bbl, and finally the collapse of Lehman brothers, with each event constraining growth in one way or another.

The reason why these became the two focal points is that they represented two extremely
large global imbalances that needed to be resolved before strong global growth could
comfortably resume. In the financials the imbalance was excessive debt and leverage and
in energy it was the production capacity utilization rate which was near 100%. Note that
even today during one of the worst global economic recessions since the 1930s, oil production capacity utilization is near 95%.
Clearly, the market needed to deal with these imbalances, as not only did they constrain growth but each one exacerbated the other –
higher oil prices exacerbated the savings glut which in turn fueled more demand via
leverage. By early last year, the two most favorite trades became long energy and short
financials as the imbalances were so obvious.

But now, they say, financial imbalances are beginning to be addressed; but the opposite is happening for the energy crisis, as the lack of investment is storing up an even bigger problem.

The growth in supply will simply not keep up with steady growth in demand – supply growth over the next five years looks to be 0.75 per cent ‘at best’ while demand growth of 1.8 per cent is implied.

The key is that oil demand in the OECD countries needs to decline to accommodate new oil demand growth in the BRICs.

Peak oilists, don’t get too excited yet: Goldman believes the problems constraining growth in supply are political, not geological: poor regulatory environments, natural resources protectionism and inadequate infrastructure.

Related story:

Markets: Oil rises as Goldman turns bullish (FT Energy Source, 04/06/09)

Energy Source is no longer updated but it remains open as an archive.

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