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This is why Goldman thinks oil is headed to $20

CNBC logo CNBC 18-12-2015 Huileng Tan

Goldman Sachs sees further weakness for oil due to the worsening of already weak fundamentals after OPEC held back from cutting production at its recent meeting.

The investment bank is standing by itsprediction of$20 a barrel bottom—the breakeven cash cost for highly levered high-cost US shale producers. If oil prices fall below that level, companies will have to make output cuts in order to avert losses.

Even though global oil stock will remain below storage capacity, Goldman said the rebalancing is "far from achieved" as U.S. rig count and exploration and production guidance are "too high" to achieve the required supply decline.

OPEC is also likely to pump aggressively toward the high-end of Goldman's 32-million-barrel a day forecast as Iran resumes productions after U.S. sanctions are lifted over the next few months.

Oil storage also runs the risk of hitting constraints by next spring.

Oil prices have fallen over 50 percent in the last 18 months due to burgeoning energy supply and slowing demand.

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"The post-OPEC oil price decline accelerated as the discord between members became more apparent and the lack of a supply response more certain. The meeting confirmed our view that it is not in OPEC's interest to balance the market in the face of still growing higher-cost production," Goldman Sachs analysts wrote in a report Thursday.

OPEC's resolve was strengthened after U.S. production picked up once prices neared $60 a barrel this summer, they added.

The group of 13 oil-producing countries has kept its production ceiling around 30 million barrels a day for years, with kingpin Saudi Arabia standing firm against an output cut in order to maintain market share and drive higher cost producers out.

"Despite the fiscal challenges that low oil prices create now, the alternative of cutting production reduces long-term revenues instead," said the Goldman Sachs analysts.

Oil prices are now near seven-year-lows with U.S. WTI (@CL.1)crude prices are around $35 a barrel—below Goldman's three-month $38 a barrel forecast—while Brent (@LCO.1) crude is now around $37 a barrel.

OPEC said in its latest monthly report that the supply of oil from countries outside of the cartel will contract next year.

Some market watchers who see OPEC's strategy working eye a rebound in prices by late 2016.

Analysts at Societe Generale said in a note Friday that they expect Brent oil to rebound to $60 a barrel in the fourth quarter of next year due to a drop in stockbuild growth in the second half of the year.

"Saudi Arabia's policy change in November 2014, when it decided to stop defending prices and pursue a market-share strategy by maximizing production of its low-cost crude is beginning to bear fruit: US shale oil production has started to drop," the SocGen analysts wrote . 

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