Over the past year, as OPEC developed the unpleasant habit of jawboning the price of oil higher on nothing but flashing red headlines, targeting headline scanning algos, many compared the oil-producing cartel to another familiar institution whose core mandate is higher asset prices: the Federal Reserve. However, the similarities are not enough, and according to Goldman's chief energy analyst Jeffrey Currie, OPEC should learn from the U.S. Federal Reserve and do more to explain its long-term oil-output policies instead of just focusing on short-term goals.
The phrase Goldman is referring to is "forward guidance", something the Fed has tried (and failed at) for years, in hopes of managing market expectations. The need for such forward guidance, which has long been a staple of comments from central bankers, should be evident to the oil producers’ group after prices slumped last week following its ministerial meeting in Vienna, said Currie, the bank’s head of commodities research, according to Bloomberg.
As he explained last week after the disappointing OPEC meeting, Currie once again lamented that “OPEC didn’t provide the market with an exit strategy,” and added that “while they discussed the near-term strategy of reducing and normalizing inventories, they failed to be very aggressive in explaining their exit strategy.”
As a reminder, after last week's deal announcement which saw oil production cuts extended into Q1 2017, Brent fell 4.6% amid concerns about whether the curbs would prove effective and how they would be phased out after March 2018. A main reason for the skepticism about OPEC’s effectiveness has been the resurgence of shale oil in the U.S., which threatens to blunt the impact of the group’s cuts. A clearer signal that the group intends to expand its market share once the inventory surplus is eliminated could also address this problem, said Currie.
As Currie wrote in a long report last week referencing the "shale productivity paradox", Goldman expects a dramatic surge in shale oil production over the next two decades, peaking around 2030 at a level that is about three times greater than current levels.
“Time is not on their side as shale production will respond,” he said. “A stated market-share target would help reduce forward prices and discourage future investment as it would be viewed as a credible threat.”
US oil production has already risen by 550,000 barrels a day this year and drillers are still increasing the number of active rigs, signaling further output gains may be coming. According to the EIA, US oil production is expected to hit an all time high sometime in the next year. That wipes out almost a third of the supply reduction from OPEC and its allies and the output surge could double by year-end, according to energy market consultant IHS Markit.
As a result, Currie warned that OPEC will probably need to discuss its exit strategy soon and could look at the recent history of the Fed for ways to improve its messaging.
“At the beginning of quantitative easing, central banks also struggled with how to communicate forward guidance on the exit strategy,” he said. “Over time they got much better at such communications.”
Because one confused Fed bombarding the momentum-igniting algos with non-stop headlines about "forward guidance" was not enough, we now may be getting a second one.