Crude oil prices have been gaining steadily in the last few weeks on the hopes of a production cut agreement between OPEC and Russia, but risks for a renewed surplus later next year remain, Goldman Sachs has said in a report.
“A nine-month extension would normalise 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 report said.
OPEC’s next meeting will be held on May 25, 2017, in Vienna where an official announcement could be made about the production cut deal with Russia about whether the production cut will be extended for six months or nine months.
This deal could remove surplus oil from the market by early 2018, however, Goldman Sachs believes that a rise in production from OPEC, Russia, and the US in the second half of 2018 could lead to a renewed oversupply by the end of 2018.
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“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,” the report added. When the spot and near-month contracts are priced higher than contracts in the forward months, it is termed as ‘backwardation’.
Goldman said that in order to control prices, OPEC and Russia should extend or increase the cuts until stocks have normalised, 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 rationalisation of shale growth in U.S. gas, both with backwardation,” they added.
Oil prices fell on Tuesday, on the back of U.S. President Donald Trump’s plan to sell off half the country’s huge oil stockpile. This decision further supplements the fear of a future oversupply even as the OPEC and Russia try to revive oil prices by agreeing to cut supplies. The U.S. West Texas intermediate and European Brent futures were 0.4 percent lower around $51 and $53.60 a barrel respectively.