Goldman: Bad things need to happen for oil prices to rise

An oil supply glut has put pressure on oil prices. In the absence of voluntary production cuts, Goldman Sachs analysts say unplanned outages and disruptions may be necessary for prices to rise.

Firefighters fight to secure a burning oil well. (Image: Wikimedia Commons)·Yahoo Finance

Oil prices (CLN16.NYM) have been kept at low levels largely due to the glut in global supply.

While low prices have been bad news for the industry (OIL) and the oil-driven economies, producers have been reluctant to cut back for fear of losing market share.

In the absence of voluntary production cuts, Goldman Sachs analysts say unplanned outages and disruptions may be necessary for prices to rise.

"The rise in production disruptions – which led us last month to bring forward our expected price recovery to 2Q16 – has continued, with a later restart in Canada and more attacks in Nigeria," Goldman Sachs' Damien Courvalin said. "However, we also continue to see further evidence that outside of these disruptions, the rationalization of the oil market’s surplus remains nascent at best."

In other words, without these disruptions, the excess supply won't correct.

"This leaves additional significant disruptions in Nigeria or Venezuela, for example as necessary catalysts to bring prices sustainably above our 3-mo $49/bbl WTI forecast," he said.

To be clear, this is not a celebration of disasters like the wildfires in the Canadian oil sands. Rather, it's recognition that unfortunate events like violence in Nigeria have a real and quantifiable impact on supply.

"Rebel attacks in Nigeria have intensified and we now estimate that 610 kb/d of production will be impacted in June vs. 500 kb/d previously," Courvalin said. "The outlook for the Nigerian disruptions remains highly uncertain: some negotiations with the government started on June 6, the same day a new rebel group surfaced. With oil majors evacuating personnel and no timeline for repairs, we assume that the loss of production will persist although an agreement could lead to a sharp recovery."

Unplanned oil production outages take millions of barrels of oil out of the world's daily supply. (Image: Goldman Sachs)
Unplanned oil production outages take millions of barrels of oil out of the world's daily supply. (Image: Goldman Sachs)

Venezuela faces a whole different set of circumstances that could bring supply off the market.

"Production in Venezuela has been disrupted as well, although official and third party data point to only slight declines of 85 kb/d year-to-date through May," Courvalin noted. "Production declines are likely larger given logistical disruptions, weather issues and a lack of funds. For now, we expect that declines will moderate later this year although production will still be down 175 kb/d yoy. The recent drought has curtailed power generation but higher rains and the prioritization of oil assets will limit the impact on production. Further, while the lack of funds has led several service providers to consider leaving the country, higher oil prices, reports of bond issuance to pay them, and a sharply lower import budget will likely delay such a pull back. A further deterioration in the country’s finances or political instability present risks of larger production declines than we assume which would be a catalyst for higher prices."

Be it wildfires in Canada, rebel attacks in Nigeria, or poor finances in Venezuela, bad news is unfortunately goods for those seeking higher oil prices.

Sam Ro is managing editor at Yahoo Finance.

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