Crude Analysis
Goldman's Spot-On Forecasts Prompt Questions

By Steven Mufson
Washington Post Staff Writer
Tuesday, May 27, 2008

Goldman Sachs oil company analyst Arjun N. Murti and commodity analyst Jeffrey Currie are rattling the oil markets -- again.

Earlier this month, Murti, 39, and Currie, 41, raised their forecast for crude oil to $141 a barrel for the second half of this year and reiterated their prediction that oil would have a "super-spike" to $150 to $200 a barrel.

Prices jumped immediately. It was the third increase in Goldman price predictions in five months and the fifth time in four years that the firm's analysts had pushed past what people previously thought possible. Every other time the Goldman team had turned out to be right.

But not everyone's buying it. "For us, the whole circus concerning analysts mentioning ever higher round numbers has seemed a very hollow one indeed," Barclays Capital commodities analysts Paul Horsnell and Kevin Norrish said in a scathing commentary last week. "It serves little purpose to start making me-too statements just to serve as a piece of analyst bling."

If that seems a bit harsh, consider the back story.

Murti, who rarely gives interviews and did not give one for this article, is a graduate of Cornell University and son of the longtime dean of Harvard University's engineering school. He initially worked for Petrie Parkman, a Denver investment firm later sold to Merrill Lynch. He joined Goldman in 1999.

He first grabbed widespread attention in March 2005 when he issued a report saying a "spike" in petroleum prices would put crude oil in a range of $50 to $105 a barrel over six to 24 months. Prices had already doubled in the previous three years to the bottom of that range and at the time, his forecast of another leap seemed farfetched.

But six months later, after Hurricane Katrina helped push prices to $70, the Wall Street Journal ran an article saying "No one on Wall Street is laughing at Arjun N. Murti now." The next year, he was invited to join the firm's partnership pool. In September 2007, he boosted his forecast to $80 to $135 a barrel.

Still, last December, when Goldman Sachs raised its outlook for 2008 crude oil prices to $95 a barrel, it seemed like a stretch. Prices were approaching that level, but they had already climbed two-thirds in 2007 and seemed poised to slip back. By early March, however, oil prices had glided past the firm's targets and Goldman's analysts set their new target at $150 to $200.

By early May, after prices grew to $120, the Goldman team raised its 2008 forecast. It said prices could average $108 for the entire year and reach an eye-popping average of $141 for the second half.

"The $141 forecast is not too far on a percentage basis from where we are right now," Currie said Thursday in an interview from his base in London.

But just because Goldman's team has been right in the past doesn't mean its streak will continue. Some oil experts say the firm's predictions were fulfilled only because of U.S. hurricanes and an output cut from the Organization of the Petroleum Exporting Countries a year and a half ago. They fault Goldman for underestimating future oil supplies and overestimating future demand for oil, especially with prices this high. Others wonder why Goldman anticipates a big price increase later this year when supplies seem adequate, even if it does expect scarce supplies years from now. Some say Goldman -- which acts as an oil broker, runs the biggest commodity index fund, provides investment advice and trades oil on its own account -- has too many institutional conflicts of interest.

Some rival analysts also wonder why Goldman has kept relatively modest ratings on some oil company shares while predicting spikes in crude oil prices. It has had a neutral rating on Exxon Mobil stock, for example, for most of the past year and a half. The company has turned in record profits and its stock has been up about 25 percent during that period.

"If oil prices are going to go to $200, why do you have neutral ratings on oil stocks?" asked one oil analyst who spoke on condition of anonymity because his firm doesn't want to be seen denigrating other firms. "Wouldn't you be saying they are screaming buys?"

Currie, who did his dissertation at the University of Chicago on the global geography of the oil market and joined Goldman in 1996, asserts that the firm's analysis is reasonable and that the world is seeking "a new equilibrium" for oil prices.

"World GDP wants to grow at 3.8 percent, whereas the best we can come up with for trend supply growth is 1 percent," he said. "So something has to give. And that means prices have to rise to curtail demand growth."

Unlike the two 1970s oil price shocks, Currie says, this one is demand-driven. When prices soared in the '70s, the Iranian revolution and subsequent Iran-Iraq war took 10 percent of the world's oil off the market. Demand had to be trimmed because supplies were cut.

"This time around, supply didn't collapse like the '70s. Rather what we saw was demand in emerging markets exhausting the capacity of the system to deliver or produce oil. That separates this period from what we've seen before." It is, he says, "much more of a demand shock this time around."

Unlike T. Boone Pickens, the former geologist and billionaire hedge fund manager who said last week on CNBC that the world simply can't produce more than the current 85 million barrels a day, Currie says that the problem holding back global petroleum output is political, not just geological.

He ticks off a list: "Canada forbids the use of nuclear power that could cut the cost of tar-sands production; Saudi Arabia is closed to foreign direct investments in oil; Venezuela has effectively nationalized their oil resources, and more governments in the area threaten to follow the same path; the Mexican constitution forbids foreign investments in energy; and Kazakhstan has restrictions to the employment of non-Kazakh engineers."

As a result, oil investment capital flows to the places most accessible, "which is usually high-cost, low-yielding and drives the long-term costs of the industry higher and higher."

Ed Morse, chief energy economist at Lehman Brothers, calls Currie's analysis "responsible and analytically coherent," but he doesn't agree with it.

Currie is too pessimistic about future supplies and exploration costs, Morse says. Morse says that new deepwater drilling equipment will break the bottleneck slowing exploration of promising areas offshore Brazil, Alaska, Norway, West Africa and northwest Australia. "The thing that has stymied new discoveries most is not acreage so much as the ability to explore it," he says. There are 70 deepwater drilling rigs in the world, according to oil service industry sources, and about 70 under construction.

Morse says new equipment will stabilize exploration costs, meaning that today's prices are more than adequate to provide incentives for new production, even with political obstacles in oil-rich nations and with OPEC countries keeping some supplies off the market. During testimony last week before Congress, Shell Oil President John Hofmeister said that a price of crude oil "somewhere between $35 and $65 a barrel" was probably adequate.

Currie also doesn't think Saudi Arabia will fulfill its pledge to boost capacity to 12.5 million barrels a day by 2011. He says that Saudi Arabia isn't investing enough and that the "geological environment is more hostile than expected." Morse says he doesn't discount Saudi pledges.

To some, Goldman's series of rising price forecasts summons memories of the technology bubble in the late 1990s, when a high-profile analyst set a price target for Amazon stock, which sparked a quick run-up in the price of Amazon shares. Then the analyst raised his target again, and the stock price jumped again. So he raised it another time, to a multiple of his original target and much sooner than the original target date.

Currie rejects the tech-bubble analogy. "When you look at an equity, its valuation is determined almost entirely by . . . expectations" of future earnings and cash flow, he said. "It is not grounded in today; it is grounded in tomorrow. So it's very easy to get a very large speculative bubble."

By contrast, he said, "commodities are physical assets where price has to clear supply and demand today." During past speculative bubbles, such as those in Dutch tulips, commodities or U.S. housing, "people hoarded," Currie added. "They had to stockpile and put things in inventory. We know that [oil] inventories are modest right now. We know that."

Morse thinks he knows differently. He says excessive prices have already hurt demand, leading to inventory buildups. He points to 30 million barrels of Iranian stocks of low-quality crude and a 65 million barrel increase since February in oil in tankers at sea.

Roger Diwan, a partner at the consulting firm PFC Energy, adds that people speculating about rising prices don't have to hoard oil in traditional ways. He says the financial players -- such as pension and hedge funds or firms like Goldman -- that are driving the market now don't need to own ships or tanks; they can just bid up prices on the New York Mercantile Exchange, where they can buy on margin. "The paper market is infinite," he says, "and you don't have to pay for storage."