« Exchanges at Goldman Sachs

Commodities Outlook: Return of the New Oil Order

2019-01-22

Making a comeback alongside higher spot prices this year will be the rapid growth in US shale, says Jeff Currie, with new pipeline capacity unlocking supply from the Permian Basin and re-anchoring the market around a fast-cycle, lower-cost New Oil Order.

This podcast was recorded on January 10, 2019.

All price references and market forecasts correspond to the date of this recording.

This podcast should not be copied, distributed, published or reproduced, in whole or in part. The information contained in this podcast does not constitute research or a recommendation from any Goldman Sachs entity to the listener. Neither Goldman Sachs nor any of its affiliates makes any representation or warranty, as to the accuracy or completeness of the statements or any information contained in this podcast and any liability therefor (including in respect of direct, indirect or consequential loss or damage) is expressly disclaimed. The views expressed in this podcast are not necessarily those of Goldman Sachs, and Goldman Sachs is not providing any financial, economic, legal, accounting or tax advice or recommendations in this podcast. In addition, the receipt of this podcast by any listener is not to be taken as constituting the giving of investment advice by Goldman Sachs to that listener, nor to constitute such person a client of any Goldman Sachs entity.

Copyright 2019 Goldman Sachs & Co. LLC. All rights reserved.

This is an unofficial transcript meant for reference. Accuracy is not guaranteed.
This is exchanges Goldman Sachs, where we discuss developments currently shaping markets. Industries in the global economy, objects, Ewart, Global, had of corporate communications. Here, the firm today's episode is all about commodities from been driving recent volatility to the role of shale in two thousand nineteen to the impact of geopolitical risks around trade and OPEC, and much much more to talk to all. This We're joined by our very own Jeff, curry, global head of commodities, research and Goldman Sachs Investment. Research Jeff welcome to the program great thanks, a pleasure to be here so let's start with the big sell off that closed out the year, two thousand and eighteen and the rebound we've seen since. What's driving these big swings, commodity prices, and you expect that to continue in two thousand nineteen. Well, let's talk about what was fundamental and then what was sentiment every begin with the a mental ships with energy. You
U S foreign policy that disappointed many of the oil producers in terms of providing functions around iranian export? So I would say was the actual trigger. If you look at the picture, you have more supply out of a random. What most people initially thought that created the initial sell off, but it involved many more assets, then oil within about two to three weeks later you had equity markets, the credit markets, I'm beginning to participate in a large saw that I would chalk. Two more sentiment, then: fundamentals yeah, We saw a caning and the underlying macro data during data time, but nothing to justify the maggots, Mood of that sell off that we saw the way I am interpreting what happened? Really is that the market got who excited over the term global synchronous growth back in late two thousand and seventeen, and really two thousand and eighteen. This career
the substantial rally in risk assets, but now that we look at the hard data and we look back at two thousand and eighteen, it was really- amid cycle, so we used the term late. We're going, have a cyclical upswing, that's consistent with late cycle economic activity, that's gonna, drive com, price is substantially higher the reality is. It was much more mid cycle and if you actually just look at this, survey, data relative the hard data towards the end of two thousand and eighteen, what we see is a survey. Data just came back in line with our data, so the way I like to think about what happened in December. Wasn't we had an absolute collapse in. Vexations and economic activity, but rather the exuberance that we priced into the market in late, seventeen and eighteen was really taken out of the market. To make this point, let's just look at oil prices today
about sixty dollars a barrel where were they in late? Two thousand seventeen before global synchronous growth was the buzz. They were at sixty dollars a barrel, copper at six thousand, then it's at six thousand now equity evaluation, the average over the post crisis era fourteen Where did the trade down to fourteen and a half list is on, and I we just centrally unwound all that exuberance over that time period one of the interesting turned last year with this high. It's what you call the new oil order, which is the arrow. Cost shale and relatively easy supply. The US being a big swing producer is shield back in the driver's. This year's you see it let's. First what we mean by the new oil order, these shale technology. Which is fast cycle, flattened out the oil supply curve. We go back. To the nineteen nineteen in the two. Thousands, when you'd have explosive oil prices or even the seventies, it was because the supply Kerr had a hockey stick formation.
It was very, very steep out on the end part of that steepness was because it would take years to bring on supply meaning that if I did a big deepwater offshore platform it require ten twenty of billions of dollars and would take five plus years to bring online. In contrast, shale wires. A couple million dollars in some cases can be brought on and mine in fourteen days. So what does it flattens out that supply curve? So when we came up with the idea of the new oil order. We realize that if you don't have that steepness in that supply curve, it changes the behavior of OPEC, think about if you're, If you know that the non OPEC play take five years to bring on supply, you can cut supply yourself. Let price go up and not worry about losing market share, but when she is active if they let prices go too high, they lose market share. So what
happened in late, seventeen for us to call a high. It is to the new oil order. It was several factors. One was that we had pipes. Capacity constraints coming out of the Permian Basin in the middle of the United States, so you couldn't grow. That shale is quickly as you could before. The second factor was that we had problems getting on some of the non OPEC Ex. U S production, then. The third factor demand demand was much stronger than we thought it started, pulling us out towards that hockey. Stick so now, I'm I'm looking at you the green light to start cutting back production without the patent, the losing market share I could say they were completely losing market share. They did lose a lot of market share last year, but not to the same extreme. If you just had completely deep, neck shale production. So calling the new oil order back on mine again in the room, This is why we say that is that the investment that we have seen
in pipelines in two thousand and eighteen and were beginning to see in early two thousand nineteen will be sufficient to de bottleneck, the Permian such that you can start to see that rapid growth, again. The question then becomes: what does this do to to prices in thousand and nineteen? Will you downgraded prices recently? Is this the reason why absolutely well actually two reasons: I'm not gonna completely discount all that noise, he saw in December. We did see a sharp ramp, in production in a of the reigning sanctions going into play in November. When didn't happen, you had all that excess apply left over. Created an inventory, build and put downward pressure on prices. Part of our forecast revision, in which we too two thousand and nineteen prices to sixty two dollars and fifty and from seventy dollars per barrel downward vision had two components. One was that excess inventory created by the iranian sanction not going into the.
Same effect, as initially thought. The second has to do with this bottlenecking of shale, because when you, bottleneck. The shell, you lower the cost structure. You move yourself back to the new oil order. So those are the two real core reasons why we lowered our price forecast on the demand side. You've said we're in basically a new kind of oil cycle that we're unlikely to see the demand pick up, in the same extent that it has in late business cycles. In the past, talk a little bit about the dynamics that are play there. I liked to say we got hoodwinked by sent in two thousand and eighteen and one of them why we thought we were going to get that late cycle. Uptick was because the survey data was so strong towards the init thousand seventeen again going back to that buzz global synchronous growth, you get a late cycle uptake using substantially increases the demand for oil and combine so give you an example why you get that big upswing,
say you have a bulldozer and you're doing construction once that construction really begins to pick up late cycle you're. Turning on a lot of bulldozers, and so the cyclical upswing in diesel demand is met, save, as you become late cycle, what happen? Was we didn't get that late cycle uptake embedded in core reason why we were very bullish on commodities going into this time period. You look at our numbers and give you an idea, we had fork Oil demand growth of one point: eight million barrels per day. A year ago. It turned out to be one point: five. Now we think about one point: five million barrels per day. What do you think they ask as in the post crisis era, one point five way. It goes back to my point: everything is really kind of boy in right now. This has been a long drawn out cycle with not much very asian around it. How However, when we look at what happened in two thousand eighteen, there was another dynamic and we called it the terrible trio, the terror
trio are rising rates straw, your dollar in higher oil prices, you put those three together. It very punishing to emerging market places. Like Brazil, we saw a truck strike in In two thousand and eighteen places like India, history firstly, when you look at the terrible trio and when they occur, it's usually a signal of two things. He midst go pause or an outright recession. We should have heeded observation more serious, last year. Why didn't we can The the dollar weekend take take off the pressure oil prices. Prices continue to go back up without doing too much damage to demand We look at the current environment, its relatively every undermine GDP growth going forward, but we look at economic, our macro backdrop, it's actually very supportive to oil and commodities, why we can comfortably say
that is on pause were unlikely in a recession. That's classic mid cycle pause amidst pause is a buy signal for oil and Kabadi. So that's point number. One point number two Strong dollar backdrop is ten turned into a weak dollar backdrop. We started the year with substantial weakening and the dollar again that created, Hale went to hire commodity price, primarily Gore, related to the expectation around the FED. There's two factors: we think about the expectation of channels really important there. Another one. When you just think about places like Brazil last year when you have a very strong dollar and you look. The oil prices, the eighty five dollars a barrel to the right the world even the UK. They were higher to the rest of the world and they were in two thousand and eight when we read one hundred and forty seven dollars a barrel, so it creates a lot of economic hardship for many, to the world that are not dollar In fact, I like to say: there's always a super cycle and commodities going on in the world. Just pick your currency, and so me
about what happened in two thousand and eight the! U S was one that needed the slow down its consumption of oil, so the price of oil exploded in dollars, but because a dollar was so weak there the world didn't feel the pan. Last year, went to eighty five five dollars a barrel, the dollar so strong places like Brazil had I equivalent of two hundred dollars a barrel, so very, very punishing our key reasons why you ve got a tale, when's one rates. That is on hold dollar is weaker. The other big one is passed seen in this market is very light. You ve a lot of the key investors in these markets in that sell off that occurred in December, so that you think of the current environment, the markets, not that long, which means as the more gets long likely go higher another the reason why we think we want to be abolished in two thousand and nineteen has to do with OPEC. Opec brought up the supply on anticipation of I ran but again, like us before a lot of that has been unwound and you
we see OPEC and we see the evidence already they're gonna cut production to take out that excess him is built up final reason on wanting to be foolish on oil, commodities really has to do with China. That's always very critical to the outlook. For oil and commodities is that China's growth has been running a little. Below six percent, they hit their policy targets at the end of twenty means they got to have six percent growth. They can't sustain. Too long of a period below six they're running in that low five right now, so we think policies likely to stimulate as we go into two thousand and nineteen. So it's a very rob. Backdrop, for oil demand I do want to go into your question about the cyclicality of commodities and cyclicality of the business cycle. We know to know is very different in there's two key does that we like to point out that one is. If we look at the do or ability
commodity consumption. Are the consumption of durables in the economy, particularly places like the? U s it stropped sharply. We don't same as many white goods, recreational quit houses and things of that nature. That's important because big ticket items create the sick Letty, but it's not only in big ticket items. I like to look at my apple watch here. You'll days I would buy a watch, that'd be only one I would buy for ten plus years now you're. Updating them every two years, so we don't that same duration to consumption we like we had before, which means you take out some of that sick So I can say in the developed markets, the amplitude of the cycle has been reduced. The second fact has to do with what's going on in the emerging markets, particularly China. They liked him micromanage financial and fundamental imbalances in this important because they ll do it counter. Secondly, to the U S: so
if the US is really strong in their consuming a lot of the exports out of China, What is trying to do they d lever their debt? slow down the stimulus to the system. When the US is weak, that's when they typically stimulate so it it's a counter cyclical stabilized in fact to what's goin on into the U S, and so what were left with with higher frequency in the cycles in places like China, will you put the two together more likely, the cycles are faster with amplitude, but it feels like they're longer and flatter, but they would still look very much this So how do you think about geopolitical risk as we enter the new year, particularly around trade there's been a lot of noise and OPEC. You can do the geopolitical risk into three categories: trade, foreign policy and the government shut down. That's currently underway, let's start with trade as we go into the year? I think both parties are in.
From where they caught a come up with some type of a deal. I know at this point consensus view as if things go on and on, but you are starting to see us substantial hit to overall global a global trade has dropped from running around six percent. To somewhere around three percent, so is starting to have a material mpeg and I dont think either party wants to see this get much worse in the current environment. So c of two thousand and nineteen brings a deal there. Clearly I think that the CAN is views has gone gone away. That is going going to go on forever to a higher probability that you get a deal think obviously the idea would be very beneficial to emerging market assets well as to commodities. Let's go to the second one which foreign policy for us, in committee. This has a huge impact weather, It was. The sanctions on route aw and the impact it has had on aluminum but much larger, the that the macro space, where the iranian sanctions
what I find kind of interesting these are all beneficial to the, economy, whether it's aluminum steel, where you see the tariffs and the case in oil it Zira that ended up being a very uncertain environment, particularly back in October and November, because most market participants view that There was a very high probability that the United States was going, Take a ran down to zero exports. Why you had people building precautionary inventories around this, you had the OPEC countries beginning to ramp up production, but the form in the? U S was very surprising because they actually is the high number of sanctions that were unexpected? So you have much more iranian oil supply as we sit here early January and the government is currently shut down. It illustrates these broader policy risks that are associated with the government. I think it does illustrated
The economic and policy uncertainty. There is rampant in these markets recently and you think of that What is an impact? It impacts Longs Michael Investment, which really brings us back the commodity story. Where now, getting the investment that we need when we start to think on a much longer term basis. Last year on the podcast, you talked a bit about cryptocurrency is any explained that one angle out there in the public was to view crib as a commodity. I've seen lots transpired in in the criminal market, telephone, issues and volatility added today's options up against other stores of value like gold, the biggest takeaway from price action and cryptocurrency last year was the high level of volatility both to the upside into the downside. The advantage that gold has is it have the same type of volatility. So if you was or a value you something that hey, if I buy it, and I put it in storage and
I pull it out. Six months later, it's going to have a value for your hope, a little bit higher than what it was when you put it in storage, a problem with those cryptocurrencies. You have no idea the file Security is hundreds of percent collapsing by fifty percent. We look at called. It went up five ten percent in some of those period that's much more reasonable store by, and I never go back to the point that I made a year ago when we think about What is the economic problem that a crypto currency solves first, less ass? What its physical characteristics are? It's the very first time take Lecter, ironic or digital money off the grid. We ve had like chronic money for decades, but what was different as you could take it off the grid and put it in your pocket, one of the little key fobs and walk away now the economic we you want want to do that to one one seal that money from the government or somebody else hide it or two
as you have no banking, in which he could use so one for illegal reasons, are gray market like to say the second one is because you don't have a banking system regions in the world. I have banking systems, some of these emerging market, so there is a real legitimate reason, but it's relatively small, and then we look gold. Gold is a well established. Has institutional arrangements? Has? studio capabilities who put altogether, you look at gold. It is still an excellent store value. So I said a year ago we still like gold, you know like, then was that last year, crypto currencies about five years, a trading history there. Now they have six gold has three years of trading history, so I'm going to stick with with my gold so commodities. And when we talk about commodities, oil gets a lot of the attention. But there's obviously some other really important ones, let's tick through some of them. What's your outlook for not gas,
the line I like to use for natural gas is long term surpluses. Create near term shortages. Why is that Very much like the new oil order in the oil story. We have access natural gas. Due to the shale revolution, this excess surplus down our pressure on long term prices. We have a long term surplus out there that you cannot be resolved. You ve, been lot of pipelines out and the Marcella, which is the big producing base and in the northeast these pipes to come online this year, it more than adequate to me all of the energy demand. The power demand, the industrial demands we got more than enough gas than we possibly need. However, was pipelines are not there? so that's. Why argue long term surpluses create the near term shortage because prices get too low. You create too much debate. For my power generation and then
get caught short like we did in November of last year in prices begin to explode on the front end, but they never moved on the back end again that long term, as we go into two thousand and nineteen more and more are those pipes come on mine. That surplus starts become reality and so right now, prices are trading around three dollars in him and be to you that long term circle number is two dollars and seventy five So by the end of this year, we, We have arrived at those long term surpluses and why our forecast is two dollars and seventy five cents how about some Metals, copper and aluminium you mentioned, but withdraw click on those I like Mr Solana, that Jake does have a commodity, background aluminum boy. That's right! That's right! of aluminum and copper. The story, in the metal space is really what we call a value proposition prices
Doug down to the costs curs across these different markets. Why were severely impacted by the trade war mentor. Of thinking about the manufacturing sector in China. Consumes copper side, fifty percent of the world's copper. So if you slow down that manufacturing sector you're going to have a significant impact on copper, so that push prices back down The cost structure we ve been bouncing around those level since July of last year were bullet. In two thousand and nineteen, not because we think you're gonna get a resolution to the trade war, but more so from the macro backdrop, we about it before you've got a lot of tailwinds to these markets. Let's start with China, because it's the largest consumer economic this sub six percent. They need a hit those targets at six percent by twenty twenty more. Clean and not they're, gonna stimulate which really be to help the demand from China
One reason the other reason is, and you got the fat on pause that creates weaker dollar, environment and for metals the dollar's really important, because then it goes that night the correlation that referring to to very very dominant in the space, so you get away speaker: dollar, stronger China, that's where we see the upside or are on on copper or seven thousand dollars a it's currently trading around six thousand dollars. One of our stronger views, something in the common market, the snark getting enough attention that you think deserves a bit more focus. I would argue its This idea that spot prices solve surpluses forward prices solve sort We had a commodity, boom a decade ago, still have a lot of commodity supply out there, whether it is in places like China, he shall we talk about with the new oil order, school over. Why you need a spot price to solve these problems when
have a shortage. You need to attract capital to the markets. To make investments was the best way to do that lock in the returns, because then you know have uncertainty about prices crushing you and you're not getting return on in Munich. Is multi billion dollar investments. So if you need saw the shortage you turn to forward long term prizes in. Were seen in these markets. Is that more of the activity is moving to the spot price which is concerned. With the idea that we have a surplus. To this idea, spot prices solve surpluses, long term contracts or for prices solve Shorty and I want to talk about it even in the context of the ECB. My can political and certainty that you were referring to recently. We can see it in the survey data when you look, the survey data. What is declining in Serbia are new orders. What is Tony, his people are unwilling to commit to forward volumes
and so when you have a lot of uncertainty too much access supply. Why happens. Is you see more and more of the market gravitate to the front and are to the spot base now right now? What that it does is it creates a very liquid front in physical market, but it starts to discourage the investment and I'm using term before in full for is we have inadequate long cycle investment because so much on this is the real story with copper and, to a lesser extent, noise like the big, deep water, offshore Florence were not getting an adequate amount of investment. There am I right bullish this year, really polished next year, maybe by Twenty one. It starts to become a much more serious problem, since we look by twenty twenty three or twenty twenty five? You start to create a big hole, because that lack of investment in long term prices, because people have no confidence in the future to make those type of
but nor are they trading out that far and the curve in right now Everything is on a prompt basis, so Jeff you in and around this industry, deep in the industry for decades now, what's the thing you'd say about the commodity market, its most misunderstood the size of the investor community and commodities always substantially overestimate when I see did these markets pray when you are back in the aluminum industry. There are very few investors in fact to say there was no hedge funds that traded commodities. Why started? In the night, key nineties. They started in size in the two thousand, when you had a trendy market, even so How many put some numbers around the size of the investor community in these markets? When you look at that, it'll open interest of the oil market? Obviously fifty percent of it is on the producers meaning real people who produce oil
upper aluminum selling forward commodities, and that's why they were invented. We actually look at their regional markets? They were the agriculture markets, invented for the front exactly so are fifty percent of the market, the other five percent of the market are going to be. Consumers can sue There's like airlines. In the car company for metals, and then left over with about fifteen percent of the market, that are investors they're, always on the long side, mostly on the. I may make that point as to why, when we think of oil. You have these big large entities that can sell oil, but you and The consumers oil at the pump. We're not going to hedge which is why you have a mismatch. We have a lot more big concentrated producers that can sell, but a UN concentrated group of consumers, so there you need the investors to fill that gap.
Represent about fifteen percent of the market. Of that one thousand five hundred and ten of it are what we call passage and dusters that trade, these commodity indices, that's like our pension fund, Hedge now are gasoline price risk and then, of the market or the hedge funds. Let's call them active investors that group is strategic or pass or only five percent of it. But I like to point out that five percent represents round seventy five percent of the trading volume, so they pack a big punch, which is why focus on them, but they are relatively small. So, if you ask me what's, the common misperception is if you read the newspapers, you think that the end air commodity market was driven by a bunch of speculators. That's just not the case. Question: we just got into the new year. What's one of your new year's resolutions, when I look back was the biggest mistake we made last year. We got hoodwinked by two optimistic sentiment,
my resolution in two thousand and nineteen is not to get hoodwinked again this time by not negative a sentiment. Well, Jeff, for joining the programme is good to have? You are excellent thanks for having me that can cause This episode of Exchanges Goldman Sachs thanks for listening, and we hope you join us again next time, the ass. Well, recorded on January tenth, two thousand nineteen, all price references and market forecasts correspond to the date of this recording. This podcast should not be copied distributed, published or reproduced in whole or in part the information contained in them, pop, does not constitute research or recommendation from any Goldman Sachs Entity to the listener. Neither Goldman
nor any of its affiliates makes any representation or warranty as to the accuracy or completeness of the statements, or any information contained in this podcast in any liability, therefore, including in respect of direct indirect or consequential loss or damage, is expressly disclaimed. The views expressed in this podcast or not necessarily those of Goldman Sachs and Goldman Sachs is not providing any financial, economic, legal, accounting or tax advice or recommendations in this podcast. In addition, the receipt of this podcast by any listener is not to be taken as constituting the giving of investment advice by Goldman Sachs too. That listener, nor to constitute such person a client of any Goldman Sachs Entity.
Transcript generated on 2021-05-20.