Oil Prices Near $50: Why Investment Banks Were Wrong on Oil

by Raul de Frutos on MAY 19, 2016

Oil prices gained further traction this week as prices climbed above $48 a barrel, the highest level in eight months. Goldman Sachs said in a report on Monday that the oil market has gone from nearing storage saturation to being in deficit much earlier than the bank expected, adding that the global oil market likely shifted into a deficit in May.

Goldman Sachs gave a bearish forecast just a few months ago, some other banks even predicted oil prices as low as $10/barrel this year. So, why were these predictions so off?

The answer is simple: predicting what the price of an asset will be in the future is not possible. Well, it’s as possible as winning in the roulette game, you need a bit of lack, but you can’t do it with consistency. A smarter way to look at the markets is to forget about predictions, have a strategy with rules and react to present information.

Right or wrong, Wall Street needs its prophets. They perpetuate the myth that there is somehow a way to predict the market every time. I guess individuals need these predictions to take less responsibility for their own investment decisions. At the end of the day, you wouldn’t feel too stupid if the expert was wrong too.

Market Shifting Into Deficit

Although there is still plenty of oil in the market, most analysts agree that the world’s crude oversupply is slipping into a deficit as the oversupply has narrowed in recent weeks thanks to supply outages in Nigeria, Canada and elsewhere combined with stronger than expected demand.

Oil prices are acting strong and we previously noticed that the Doha meeting marked an inflection point. The failed Doha meeting is an indication of how strong market sentiments currently are. On another day, this failure reach a production cut deal between major energy producers would have translated into a big sell-off.

More Bankruptcies

Another factor supporting oil prices is the number of bankruptcies we are witnessing in recent months. Last Sunday, Breitburn Energy Partners LP filed for bankruptcy and just a day after SandRidge Energy Inc. became the latest oil and gas company to file for bankruptcy after joining a growing list of producers that weren’t able to survive long enough to enjoy the recent rebound in oil. Sandridge was founded by former Chesapeake Energy co-founder Tom Ward who was eventually forced out of both companies.

Despite the rally this year, most industry analysts agree that oil prices remain too low for many producers to make money, so expect widespread pain in the U.S. oil industry and elsewhere to continue. In theory, this is also a good indicator that oil prices might have hit a floor this year.

The Outlook

Despite a the more bullish forecast from Goldman Sachs, the bank sees a surplus again in the first half of 2017 due to returning output from Nigeria and rising production in Iran and Iraq, among other reasons. That’s a prediction, sure, but we’ll stick with what we witness right now: Oil prices are acting strong, supported by a more positive sentiment on commodity markets. On top of that we have a weakening dollar, which is bullish for oil and other commodities.

The situation could reverse, but right now there is no reason not to take this rally seriously. Oil prices might need to consolidate/pull-back after rising for three consecutive months but they could continue to climb during the rest of the year which would favor higher metal prices, too. Oil prices climbing above $50/barrel would be a signal that this uptrend is due to continue.

Source: MetalMiner