Goldman Sachs cuts oil forecasts; upgrades Total and BP

Goldman Sachs cut its 2016 Brent oil price forecast to $49.5 a barrel from $62 and warned there is a risk prices could fall to as low as $20, noting that OPEC production has surprised sharply on the upside and Iran has the potential to ramp up in 2016.

The bank said the market will need US production growth again in 2017 and left its Brent forecasts for 2017/18 unchanged at $65 a barrel.

Goldman said that although its base case does not assume oil inventories reach capacity, and as such it does not assume prices reaching cash costs of $20-25 for US producers, this is a risk if there’s a demand downturn.

GS said it expects oil prices to bottom in the coming six to nine months, with two key drivers. The first is that US production falls sufficiently to start rebalancing the market. The second is that the market sees US production growth is again going to be needed to rebalance the market from 2017.

The key risks to the latter are further OPEC production surprises and weaker-than-expected demand, which could delay further the rebalancing, said GS, which expects equities to bottom with commodity prices.

The bank said fundamentals remain weak across the space, with dividends uncovered in 2015/16, but this is starting to be reflected in valuations.

“The stocks are pricing around $65 a barrel and now have an average 4% free cash flow yield at $65 barrel in 2017, pre-dividends. Dividends may be cut, but with over coverage now yielding 6% on average this is becoming priced in.”

It said that even with that, valuations do not yet look compelling, although the bank moves to a ‘neutral’ coverage view from ‘cautious’.

Goldman Sachs upgraded Total to ‘buy’ from ‘neutral’ and added the stock to its Conviction List based on strong cash flow growth, attractive downstream exposure, best-in-class capex flexibility and disposal options.

It upgraded BP to ‘neutral’ from ‘sell’ following underperformance. GS noted the stock has underperformed the FTSE World Europe by 15% since it was downgraded on 16 May.

“We continue to believe that BP will be challenged in a low oil price environment without a material growth portfolio and limited disposal options. However, a lower for longer environment should be fortuitous in allowing it to extract more value from the service chain and thereby drive costs lower in its upstream businesses.”