Goldman Sachs is calling a bottom in the market, again. Here’s their reasoning – which, by the way, is still very much based on their old reasoning, just accelerated:
The faster than expected pace of OPEC cuts and continued low temperatures are likely accelerating rebalancing in the global oil market. As a result, the bottoming in prices and timespreads could be closer than we originally expected. Thus, while we continue to believe that pressure on prices will unlikely abate until the rebalancing of the crude market translates into a tightening of global inventories, we would take further supply cuts and prolonged low temperatures as sign of a potential bottoming. As a consequence, though we maintain that a flattening of the WTI forward curve will follow the current steep levels of contango, the risk of a bearish flattening, with a steep decline of the back-end, is now more balanced by the risk of a bullish flattening, with front-end prices rising to the back. Thus, we see the risk-reward of a long timespreads position as higher than an outright short position on the back-end (like the one we have previously recommended). We therefore take profits on our short Dec11 trade and open a long Dec09-Dec11 timespreads trade.
So, in a nutshell, they are recommending closing any outstanding shorts on long-dated WTI contracts (specifically Dec11 contracts), which presumably would have been taken on with a view to them falling into line with the front end. Goldman themselves say the position has made them a total profit of $7.87 per barrel since December 9th 2008.
Instead, they now recommend going long time-spreads, also known as calendar spreads. Effectively, this involves taking positions that play the differential between the monthly contracts and profiting when that differential narrows – in this case by going long December 2009 contracts and short December 2011 contracts. The position had a differential of -$11.56 per barrel on Friday 13th February. Goldman have based the view on a belief that the risk-reward of being long time-spreads is now higher than being outright short back-end futures.
Interestingly, Goldman are also saying they believe the glut in the crude market will soon filter through to the products side of the business. This certainly makes sense. Storing crude becomes less appealing when you can convert it profitably into gasoline and other products due to favourable margins. Margins have improved due to lower refinery utilisation, which is down to cuts in refinery runs — on lower demand — and the beginning of the refinery maintenance season. As Goldman rightly points out, converting crude into products also opens up fresh storage options, a good move as WTI storage options become increasingly hard to locate. As they explain:
As crude inventories approach maximum storage levels, prices are adjusting to create incentives to refine this excess crude and store it as refined products, making products a form of storage of last resort. As a consequence, refinery margins have widened, especially in the United States where crude inventory levels are particularly high and refineries are in maintenance. We believe that in the absence of further supply reductions, the surplus in the crude market will be transmitted downstream into products as soon as the more favorable refining margins promote a substantial product inventory build.
However, that said, Goldman contends higher refining activity alone will likely not be enough to eliminate the crude overhang if excess crude supply is not cut too. Which means they’re still waiting for non-Opec producers to begin cutting supply on a larger level.
Related links:
Murti’s back and he sees a bottom in crude – FT Alphaville
Forward Nymex WTI curve contracts – Nymex