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Oil prices: ‘The next move is higher,’ commodity strategist says

Goldman Sachs Head of Energy Research Damien Courvalin joins Yahoo Finance Live to discuss the outlook for the oil and energy markets amid pricing hikes, Russian sanctions, recessionary risks, volatility, and demand growth.

Video Transcript

EMILY MCCORMICK: But I do want to stick with the topic of the energy markets and bring in our next guest on the program. Damien Courvalin is Goldman Sachs' head of energy research. Damien, thanks for joining us this morning. Crude oil prices have still been elevated but have certainly come down since WTI topped $130 per barrel last month. What do you think is the path of least resistance here for crude oil in the near term?

DAMIEN COURVALIN: Hi, Emily. Yeah, we've seen a large retracement. We think the next move is higher. If you think about the move lower, you had three headwinds recently; the lockdowns in China, which reduced mobility, hence oil demand; the large SPR release from the US government; and finally, when you look at Russian exports, not as big a decline as initially appeared. So that provided some short-term relief.

But keep in mind, right, the market has been now in a nearly two-year-long deficit. We are at record-low inventories, and all those headwinds are transient. So we really haven't resolved the significant underinvestment, and that's why prices need to recover. We'll probably see short-term volatility but I guess, from this level our view is the next move is indeed higher.

BRIAN SOZZI: Damien, do you still see $125 a barrel?

DAMIEN COURVALIN: Hi, Brian. Yes, that's our forecast for the second half of this year. So how do you get to such a price level? Well, when you decompose the oil market or any commodity market, you have three adjustments; you have supply elasticity, so producer responding to higher prices; second, you have inventories; and third, and typically last, you have demand elasticity, demand destruction at higher prices.

What is key in today's environment is you don't have one and two. So you don't have supply elasticity, shale is growing but that does take time, OPEC is not doing anything in excess of its plan. Second, inventories are record low. So you're really down to having to reduce consumption.

Now, we're not saying we're at the point where we need a recession, a collapse in oil demand, but we do need slower demand growth than would have occurred at lower prices and without the Russia sanctions. So I think that's the core of how you get to $125. Now, as you saw in just the last few weeks, there will be volatility, and there is risk potentially to the upside once the loss of Russian exports become clearer and more persistent.

BRIAN SOZZI: And Damien, we've seen since we last spoke, I think we can argue that the Chinese economy is slowing down in large part because of these new lockdowns related to COVID. What does that mean to the demand environment for oil?

DAMIEN COURVALIN: So China has an efficient lockdown policy in terms of reducing oil demand, and we're seeing that today, right, their local demand is probably down 2 million barrels per day. So that's 2% of global oil demand, which is sizable. But keep in mind, right, we had always assumed that Omicron eventually would go to China and would lead to rolling lockdowns. And they're probably their most acute now. If you look at Hong Kong, for example, or the recent headlines out of Shanghai, we don't expect those to last for six months. So we expect that to be this kind of short term, call it three-month headwind. Maybe it's rolling lockdowns but still doesn't resolve the fact that you've been in a deficit that is now structural.

What do I mean by that? Well, oil demand was record high before the lockdowns. Oil investment has been depressed for the last three years. So as those lockdowns fade, then you go back to the initial problem, which is persistent underinvestment, and that needs higher prices.

EMILY MCCORMICK: And Damien, switching gears here for just a moment, later today, President Joe Biden is slated to visit Iowa and announce that he will allow US gas to be sold with a 15% rather than 10% ethanol blend to help bring down prices paid at the pump. Is this going to have a meaningful impact on US energy markets?

DAMIEN COURVALIN: That likely will be quite small. The first primary hurdle is retail gasoline station are typically reluctant to sell high ethanol blends from a liability perspective. Most cars historically were not suited for such higher blends. And so you may see it in some regions in the Midwest where you have more flex-fuel cars for example. But again, it's a marginal adjustment. It really doesn't solve the inherent issue, which is a record-long, record-large deficit on a global scale.

BRIAN SOZZI: And Damien, I was reading a good note by Jan Hatzius, the global-- the chief economist over at Goldman this morning. Now, he's not-- he's not calling for a recession but he did highlight how an overheating labor market is raising recession risk. From your camp in commodities, what would a recession in the US mean to oil prices, where do they go?

DAMIEN COURVALIN: I think the key-- I mean, ultimately, any recession is bad for pro-cyclical goods like commodities. What history shows, however, is the path to a recession typically actually sees commodity outperform every other asset class. Now, keep in mind, right, when I think about equities, this is an anticipatory asset valued over 20 years, slower economic growth, higher inflation are bad from a valuation perspective.

Commodities however are a real asset. What matters to them is today's supply versus demand mismatch. And when you're late cycle, so heading into a recession at the economy level, typically, that's when those shortages are highest, consumption levels are high, in fact, they're so high that the economy can't grow at the same pace as previously. So from here, if we were to have a hard landing, which may be driven by labor inflation, it probably is also coming with higher commodity prices. And that's your textbook allocation, right, at this point of the business cycle one should be overweight commodities to hedge against inflationary pressure and to benefit from the appreciation that is coming with a strong economy, overheating economy.

EMILY MCCORMICK: All right, we'll leave it there. Damien Courvalin, Goldman Sachs' head of energy research. Thank you so much again for your insights this morning.