PrintGoldman Sachs said the risk of oil hitting $95 a barrel - that they foresaw back in July - has been mostly realized and as a result the price-risk profile is now more balanced. At the same time, Goldman Sachs said in its Energy Weekly report that it remains extremely positive on the long-term outlook, with royalties on the rise once again.
“As we have emphasized in the past, one of the remarkable features of the current price rally has been that both long-dated oil prices and time-spreads have strengthened considerably. While the strengthening time-spreads have followed the declining inventory and possibly embedded some geopolitical risk, we believe that the rally in long-dated oil prices is the result of continuing industry cost inflation and the need to incentivize investments in one of the most difficult investment environments that oil companies have seen in years. Even at the current high oil prices, the production capacity expansion is lagging behind and project delays and disappointments in reserves expansion continue to characterize the oil industry,” Goldman Sachs said.
Goldman Sachs said that it has long held the view that the primary driver of the sharp rise in long-dated oil prices that pulled up spot prices was increasing costs due to the need to build long-term production capacity following the depletion of excess capacity across the supply chain earlier this decade.
Once capacity was exhausted, the resulting physical shortages in 2000 - 2003 forced the market to shift from a two-decade-long “exploitation” phase to an “investment” phase in which new investments were required to grow capacity and the supply base. During the exploitation phase, supply was increased by simply increasing utilization rates or “exploiting” the existing capacity, which is very low cost. In contrast, growing supply through investment is a substantially more expensive, time-consuming and risky endeavour, which has historically created upward pressure on prices
“We are now six years into the current investment phase and very little spare capacity or new greenfield production capacity has been added, which underscores how much longer this investment phase will likely last,” Goldman Sachs said, adding “We believe that the investment phase has at least another five to ten years left, and has run into significant road blocks in 2007, resulting in substantial supply disappointments. One of the key factors that have helped to drive up costs over the past several years has been regional government taxes on oil production profits.”
Specifically, West Africa, Russia, the UK, Canada, and various Latin American countries have pursued very aggressive tax regimes on oil production profits, with Venezuela even shifting to the extreme of the nationalization of its assets. These policies substantially increase the costs of production and the price of oil required to incentivize investment. Over the past few weeks, Canada, Nigeria, and Kazakhstan have all suggested higher government royalities on production.
Goldman Sachs noted that “although we remain structurally positive on the market as industry cost inflation continues to support long-dated oil prices and the expansion in production capacity is still lagging, we are now more cautious on the near-term upside potential for oil prices.”
Accordingly, Goldman Sachs said in its Energy Weekly report that it is now recommending to take profits and close long WTI and long agriculture and gold positions.
“We are not trying to call a top here, just take profits from a tactical perspective, as prices could continue to rise in the coming weeks, but the recent strong rally will likely bring forward the short-term rebalancing of the market that we expected for the first quarter of next year,” Goldman Sachs said.
Before the rebalancing takes place, prices could well trade above US$100/bbl as near-term upside risk factors persist;
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