Goldman Sachs: Shale Drillers Add to Glut

Goldman Sachs has diagnosed a new reason for the sudden slump in energy industry sentiment this week: talk of agility, not agony, among leading U.S. shale oil producers speaking at the Wall Street bank's closed-door conference.

In a research note following its Jan. 5-7 Global Energy Conference in Miami, which was closed to the media, the analysts said that investor sentiment "deteriorated further" during the event for three reasons, including a view that drillers were still overly optimistic about the potential for $50 oil.

"Investors felt producers were not being responsive to $35 a barrel WTI (West Texas Intermediate crude oil) by focusing more on their agility versus potential for their production to decline," they wrote.

Unfavorable weather and weakness in the Chinese economy also weighed on sentiment, the analysts said in a note entitled "Are we there yet?". They also said Pioneer Natural Resources (PXD)' $1.4 billion equity offering this week "increased investor concern that financial stress is insufficient to bring oil markets back into balance".

While the note is focused on energy companies rather than the oil market, it offers a new perspective on the dramatic 10 percent slump in crude prices this week that traders blamed on a variety of other factors, including a dive in the Chinese stock market and a sharp rise in U.S. gasoline stocks.

It also reinforces the core thesis underpinning the bank's ultra-bearish outlook on the oil market. Its market analysts have been warning that a $20 a barrel price shock may be necessary to accelerate the slow-down in drilling and prevent global inventories from overflowing with surplus crude oil.

So far, the U.S. shale oil drillers have proven stubbornly optimistic about the outlook, doing everything they can to maintain output even as cash dwindles and, in the process, feeding the glut that has depressed global prices.

"Investors were looking for fear and trepidation from producers but got agility and below-expected clarity instead," according to Friday's research note.

The analysts said that producers such as Continental Resources Inc, Devon Energy Corp and Marathon Oil Corp had assumed a $50 a barrel price, and indicated they would have to cut back on spending if the forward price curve dropped below that level. The balance of 2016 was trading at around $38 a barrel on Friday.

None of the firms posted any material on their websites by Friday.

It will likely take several more months to see whether the response among drillers would be enough to shore up prices as drillers get into the "mindset" of $40 crude, they wrote.

"At our conference, producers largely did not provide specifics on what capex/ production would look like at $35/bbl oil," they wrote. "Instead, producers spoke largely of their agility to spend within cash flow and ... ramp up when needed."

And when might that be?

"Commentary suggested $50 per barrel WTI is now where producers would raise activity."

Reporting by Sneha Banerjee