Oil prices took another tumble Monday, not because of any new problems with the global economy or Saudi Arabia turning up the oil taps, but because the self-styled Smartest Guys In The Room said it should.
Analysts at Goldman Sachs slashed their forecasts for the crude price next year to around $5 a barrel below the market’s expectations. That pushed the price of the benchmark futures contract down by over a dollar to $79.53, its lowest level in nearly three years (although it rebounded a little later). Goldman’s team of analysts, led by Damien Courvalin, think it can go as low as $75 by the first quarter of 2015, and after a bounce in the spring, return to that level for the whole of the second half. They then see it averaging around $80/bbl through 2016.
Goldman’s new estimates are the latest evidence of broader shift in the way people look at the market for the world’s most important commodity. For most of the last forty years, the price of oil has effectively been in the power of Saudi Arabia, which had a large amount of spare production capacity that it could start up or shut down to keep supply and demand in balance.
But the reality for the next few years, many people (including Goldman) now think, is that U.S. Shale oil will be the ‘swing producer’. Saudi’s spare capacity has shrunk, while billions have been sunk into shale projects that can survive on an oil price of $80 or less. If the Organization of Petroleum Exporting Countries decides, as it has done in the past, to target a price of $100/bbl, it will find that U.S. Production just increases further, bringing the price down to $80, at which level it wouldn’t make sense to invest in shale.
“While we still expect that O.P.E.C. Will remain a swing producer, we have greater confidence in the scale and sustainability of U.S. Shale oil production. This implies that the global cost curve has shifted lower and that cost deflation is sustainable,” Goldman said.
That assumption has some far-reaching consequences. For one thing, it means that market forces would have more influence in pricing the lifeblood of any industrial economy, at the expense of the cartel of overwhelmingly autocratic producers that is O.P.E.C..
That’s going to be a shock to countries that need high prices to make sure that their budgets balance. For Venezuela, which has run a staggering budget deficit of 14% of gross domestic product even with prices over $110/bbl, that means an almost certain crunch.
Yields on Venezuela’s sovereign debt have shot up as the oil price has fallen, on increased fears that the country would default. Those fears receded at the end of last week after PdVSA, the state oil company, promised it would repay $3 billion of its own bonds that fall due Tuesday. But its benchmark bond due in 2027 still trades at less than 60c on the dollar, suggesting a high risk of default.
Lower oil prices are also having an impact on Russia, which isn’t an OPEC member but which is just as dependent on high oil prices to balance its budget. Finance Minister Anton Siluanov told parliament last week that budget assumptions for 2016 and 2017 would have to be thoroughly because the original draft had assumed average prices of $100/bbl- a “different economic reality.”
Siluanov has already said that many of the government’s planned increases in defense spending will have to be pushed back if the situation doesn’t improve. Next year’s budget is only being spared because the government will draw down some $10 billion in reserves from its rainy-day fund.