Tuesday, September 18, 2007

[GS] Commodities: Super spike framework remains intact. Raising WTC forecasts

GS GLOBAL OIL CALL => Raising WTI forecasts to $80 and $90 in 08/09; no signs of demand destruction
The core drivers of our "super spike" framework remain intact: spare capacity throughout the oil value chain remains limited, supply is struggling to grow, and demand growth continues.   (Note below conf call details with GS global commodities team)

What’s changed:
1) Higher WTI assumptions
- $67, $80, $90 per barrel in 07/08/09 (vs $65, $68, $68 before)
- $80, $75 per barrel in 2010/11 (vs $45 normalized before)
2) Higher normalized oil price assumptions
- Normalized oil price (in 2012 and beyond) pushed up to $50 (was $45) reflecting cost escalation

Reasons for the upgrade
1) Accelerating demand growth in 2007
- After two years of deceleration, demand growth has accelerated in 2007 despite oil prices at $60-70/bbl
- GS expects ~1.5m b/day per annum demand growth for the remainder of this decade
- Demand growth has been the strongest since 2004 in part because the y/y price inflation has been at the lowest level in three years.  Stable oil price ($60-$80 / bbl range) has stimulated demand growth, particularly in the US and China, despite a sluggish US economy in 2007. 

- Demand at the current price is likely more inelastic (The massive rise in energy prices from late 2004 to the summer of 2006 killed off excess discretionary demand and a large price increase is likely required to slow demand growth similar to the experience of 2005 and 2006).

2) Non OPEC supply growth remains challenged
- Non OPEC supply growth has continued to fall short of consensus expectations
- GS expects not more than 700k b/day non-OPEC supply growth per annum in the coming years
3) OPEC spare capacity at minimal levels
- As demand growth continues and non-OPEC supply falls short, expect rising dependence on OPEC to grow its production
- GS base-case assumes Saudi Arabia meets its 3% per annum production capacity growth targets
- Note all the super majors have been falling short of their own production growth targets 
4) No signs of demand destruction – subsidies suppress demand elasticity
- Key Reason: 2/3 of demand growth comes from emerging economies (China, India, Mideast) where prices are heavily subsidized

- Estimate tipping point for demand destruction is >US$130 (At that level, gasoline spend as % of income will be 7% - the level in early 80s when demand growth turned negative. Today gasoline spend as % of income is 4.5%)

5) Note slower US demand growth is already built into assumptions
- GS has already assumed incremental demand from the US falls from 370k bbl/day in 07, to 270k bbl/day in 08
- Even assuming the entire 270k bbl/day disappears (ie, ZERO demand growth), global oil demand growth is 1.1m bbl/day (instead of 1.4m bbl/day)

- Still significantly outstrips non-OPEC supply growth of only 700k bbl/day

Risks: Lower US demand if US goes into recession plus potential near-term Energy equities sell-off. GS thinks oil prices will remain firm because of tight global supply and strong demand from emerging markets. 

Traders' perspective Energy and gold remain the focal points of the commodity complex leading into todays FOMC - both creeping higher in a subdued trading environment yesterday.

Oil Early yesterday oil dropped on diminishing storm fears (Ingrid was downgraded) and flow on effects of jitters in other financial market but the dip was short lived ... option expiry explained much of the late rally and the 60 cent burst after the close (beyond $81, currently $81.14)) was also seen to be gamma scramble.

We're getting plenty of questions about the best way to play the crude market to the long side in the current environment - its actually a very easy question to answer and its well illustrated in the chart below. The crude forward curve is discounted (light blue line), implied vols are historically low (red line), lagging other asset classes and there is very little Call skew that you need to pay. Six and twelve month 105 and 110 Calls make good sense and price up attractively - ie. 6 month $85 (105% of spot) WTI Call is $2.25 per barrel or (2.75% of spot (spot WTI $81)).

 

Gold

Gold traded up to $718.75 from $711.00 (in Asia) on a spot basis yesterday and has held most of those gains in pre-FOMC trading. The positioning issue is slowly gaining a focus as the CFTC reports from Friday showed a 4m oz build which is 78% of its maximum positioning; up from 40% 2 months ago. The Northern Rock issue which was seen to contribute to a $10 spike in prices on Friday, lingers in the background. ETF demand is likely to continue and one senses that money market fears are not yet easing. The vol market was mostly unchanged yesterday, with some FOMC related upside Call interest. Theres been some good sized selling around in gold this morning that seemed to be triggered by a little-dip in the EUR (USD strength) - Tocom related profit taking also going through but the market is absorbing it well - down $1.50 from the New York close.