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Why Goldman Sachs Thinks Oil Should Be Trading Higher

Nick Cunningham

Fears of weak oil demand are taking over the market, overshadowing tanker battles in the Persian Gulf, something that would have typically sent oil prices skyrocketing. However, demand may also rebound in the second half of this year, offering some upside to oil prices.

Demand only grew at a 0.95 million-barrel-per-day (mb/d) rate in the first half of 2019, according to Goldman Sachs, which the investment bank admitted was 0.4 mb/d lower than its estimate at the start of the year. It’s also the weakest start to any year since 2011.

“Despite this poor start, we see increasing scope for oil demand to finally start exceeding beaten-down expectations,” Goldman Sachs analysts wrote in a note. The investment bank cited a few reasons for the prediction, including strong consumer demand, recent positive data from the refining sector on end-use demand, plus an overall strengthening of the macroeconomic picture.

In other words, the economy soured in the first half of 2019 (and particular in the second quarter) but now things are starting to look up again.

By now, some of the data points and drivers that characterized the first six months of the year are well-known: slowing manufacturing activity, the U.S.-China trade war, tepid trade volumes and weak auto sales, to name a few. The slowdown has a direct effect on oil and product markets – weak manufacturing and industrial activity translates into lower-than-expected demand for diesel, bunker fuels and bitumen, as Goldman noted. At the same time, the consumer economy has held up better, which means that demand for products like gasoline and jet fuel has been more robust.

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But Goldman said that some of the weakness can be chalked up to weather, which may have destroyed 0.2 mb/d of demand in emerging markets in the first half of the year. Also, the increased use of natural gas in power generation in several countries – including Egypt, Saudi Arabia, Iraq and Pakistan – shaved off oil demand for electricity. In that context, the poor demand figures are less worrying that they might appear at first glance.

“While by no means an unequivocal turn in data, sequentially better macro releases in the face of low net speculative oil positioning could finally lead demand to being a supportive force to oil prices, creating transient upside risks to our 3Q19 $66/bbl Brent price forecast before the Permian basin becomes debottlenecked this fall,” Goldman Sachs said. “All else constant, we estimate that an upward revision of consensus 2019 oil demand growth expectations to our 1.275 mb/d forecast would rally Brent prices by $6/bbl.”

The investment bank also pointed to timespreads in the futures market, which have rallied. “From an oil market bottom up perspective, recently rallying product timespreads, cracks and refinery margins point to sturdy end demand,” analysts wrote. Some of the more recent economic data from China and the U.S. also points to a nascent rebound.

If things are picking up, what should we make of the recent slowdown? Goldman Sachs calls it a “transient manufacturing recession, similar although less extreme than in 2015-2016.” As a result, economic growth could resume. “With healthy consumer spending given low unemployment rates and rising wage growth, such end-demand should allow for manufacturing activity to restart,” Goldman analysts said.

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Finally, the wave of interest rate cuts from multiple central banks around the world could also juice the economy. China is also undertaking heavy infrastructure spending as a form of economic stimulus, which could offset the negative impacts of the trade war.

The conclusions from Goldman Sachs suggests that the cracks in the global economy are not as bad as feared. That would seemingly create a lot more room on the upside for crude oil.

However, at this point, most analysts are predicting that not only was the oil market in a state of supply/demand surplus in the first half of 2019, but that the surplus coming in 2020 could be even worse, absent deeper cuts from OPEC+. If Goldman Sachs is right, demand might be just a tad stronger than most other analysts believe. But that won’t be enough to stop a price slide if supply growth continues to outpace demand.

By Nick Cunningham of Oilprice.com

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