Goldman warns of 2018 oil glut amid optimism over OPEC cut extension

Oil pumpjacks in the Permian Basin oil field are getting to work as crude oil prices gain.
Spencer Platt | Getty Images
Oil pumpjacks in the Permian Basin oil field are getting to work as crude oil prices gain.

Expectations of an extension of an oil production cut agreement by the Organization of the Petroleum Exporting Countries and major producers led by Russia are supporting prices, but there are risks for a renewed surplus later next year, Goldman Sachs analysts wrote in a report published on Monday.

"A nine-month extension would normalize OECD inventories by early 2018, in our view, but we see risks for a renewed surplus later next year if OPEC and Russia's production rises to their expanding capacity and shale grows at an unbridled rate," the Goldman analysts said.

Crude oil prices have been gaining steadily in the last few weeks but are slightly lower in Asia on Tuesday with U.S. West Texas intermediate and European Brent futures down 0.4 percent lower around $51 and $53.60 a barrel respectively, as prices give up some recent gains after President Donald Trump proposed the sale of half the country's strategic oil reserves in his budget plan, according to Reuters.

To avoid the boom-bust cycle, sustained backwardation in prices will help, the Goldman analysts added. This is as the low deferred prices will restrain access to credit for shale producers.

Backwardation happens when spot and near-month contracts are priced higher than contracts in the forward months.

"Costs will also play a role in setting shale's growth path but we do not forecast sufficient inflation at this point to achieve the required slowdown next year," the investment bank said

"In the current environment, we believe that the largest imbalance is the potential for a large surplus in 2018, leaving low deferred prices to resolve this credible threat. Low-cost producers selling their output in the spot market should further be incentivized to reduce inventories, to generate the backwardation linking spot oil prices near current levels and low deferred oil prices," they wrote.

But even with the cuts, OPEC will be able to reverse its policy as soon as 2018. Significant investments to increase Russian producing capacity and ongoing de-bottlenecking of infrastructure in Iraq can also lead to a rise in production.

"Such a ramp-up in OPEC and Russia production would occur in the face of still rising non-OPEC production outside of US shale, with legacy projects started through 2014 still coming online in Brazil, Canada and the North Sea in particular," said the Goldman analysts.

To control prices, Goldman said OPEC and Russia should extend or increase the cuts until stocks have normalized, express the goal of growing future production, and gradually ramp up output to grow market share but keep stocks stable and backwardation in place.

"Achieving this will be difficult, but we see templates in both OPEC's modus operandi of the 1990s of managed but flagged growth and the rationalization of shale growth in U.S. gas, both with backwardation," they added.

OPEC will next meet on May 25 when they will likely extend the output cuts, said the investment bank.

Goldman is keeping its Brent spot price of $57 a barrel for the second half of 2017.

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