Energy Prospectus

Goldman Sachs Commodity Research

A bullish outlook for 2023. Our 2023 outlook highlights how the set-up for
commodity markets is one of the most bullish since we first called for a
commodity super cycle in October 2020. With supply extremely tight following a
period of inventory destocking and lack of commodity capex and spare capacity
exhausted, commodity markets are vulnerable to any sequential improvement in
demand in 2023 particularly if market liquidity improves and, linked to that, the
US Dollar starts to weaken.

Time to focus on the Micro. That said, volatility is likely to remain high given
near-term growth concerns. With macro risks eventually set to diminish in the
second quarter when China is likely to embark on a broader re-opening, we
believe there will be plenty of opportunities for discretionary capital to benefit
from dislocations in commodity markets near-term. Micro stories and relative
value opportunities will then likely become the most important source of returns
going forward. That is particularly important since micro, idiosyncratic risks are
more transient relative to persistent macro risks and thus more difficult for
investors to capture.

Trading the top themes for the year. To help investors navigate the next twelve
months, we are introducing our top trade ideas for 2023, based on micro
fundamentals with relative value implementation that should help reduce macro
exposure. These trade ideas are centered around the four themes highlighted in
our outlook — namely under-investment, China’s reopening, Russia risk and the
green transition.

Commodities as an asset class to come out on top in 2023. Despite the
recent collapse in spot prices, commodities will still likely finish 2022 as the best
performing asset class with c. 20% returns ytd on the S&P GSCI, most of which
is driven by the roll yield which allowed investors to bank the price spikes from
earlier this year. We expect another year of strong returns in the region of 43%.

They expect Energy and Industrial Metals to be the top preforming sectors.

Their oil price forecast for Brent is $90 in Q1 $95 in Q2 and $105 in 2H 2023.

Once US gas markets get through this winter’s
weather risks, we believe the market is likely to enter a two-year mini-bearish cycle,
driven by a pause in US LNG export capacity additions while production continues to
grow. This will be followed by a fast tightening in 2025 driven by large LNG export
capacity additions against a backdrop of slowing production growth following two years
of low prices. Our forward outlook of a well-supplied balance in 2023/2024 followed by a
fast tightening in 2025 is consistent with a backwardated US gas curve that is currently
backwardated shifting into contango.

Their U.S. natural gas price forecast is $6.00 in Q1, $4.15 in Q2 and $4.15 in 2H 2023

They are very bullish on copper: Over the next year, we expect the continuation
of the surge in green demand and failure of mine supply burst to give rise to a
depletion-generating deficit. We have sharply downgraded global mine supply
expectations for 2023 and have upgraded our expectation for China’s renewables
demand. With a clear sequential recovery path now expected for China in 2023, copper
is set to experience a more supportive macro environment, in our view. As highlighted
recently, we also believe the LME curve is under-priced versus micro conditions, with
historical average spreads for current tightness suggesting the cash to 15m spread is
undervalued. As such, we continue to recommend investors hold a long position in
copper via the long GSCI Copper Sub Index.

Details on their oil price forecast:

Energy
Crude Oil:

Oil prices declined a further 20% over the past month, giving up the entirety of this
year’s gains. More concerning, timespreads and physical markets have weakened
substantially, diminishing the bullish spot fundamental setup that had brought solace to
market participants awaiting the implementation of the EU oil embargo last week. We
have always argued that timespreads don’t lie and, consistent with the above, find a
market that has built more than 1 mb/d counter-seasonally over the past month. This has
heightened concerns over the macro-economic outlook, and whether the recession for
oil demand is already here.

In our view, the current weakness is transient, mostly reflecting lockdowns in China and
higher-than-expected Russian flows that we expect to reverse. At $79/bbl, current Brent
pricing is reflective of flat Russian production and 0.5 mb/d lower China demand than
our expectations over the next six months (c.14 mb/d), an overly pessimistic expectation
in our view. On the former, reopening looks, if anything, likely to be accelerated. On the
latter, while Russia was a false start for 2022 balances, we continue to expect
sequential declines next year of c.0.7 mb/d as winter Baltic ice and the EU product
embargo further complicate the binding constraints of the tanker market. Physical
markets are also contending with higher spot tanker rates and destocking following
end-consumer hoarding and increases in working capital costs this year.

A difference in this business cycle is that the labor market overheating materialized in
unprecedented job openings that are less painful to unwind, forging a path to a soft
landing. Consistent with this, hard macroeconomic indicators and congestion data
continue to indicate robust spot demand ex-China. With consumer oil prices down
$50/bbl from their peak, consumers are also benefiting from a $750bn annualized
windfall. Nevertheless, we now expect a surplus of 1.7 mb/d in 4Q22 and 1.3 mb/d in
1Q23, diminishing the risk of a winter price spike. We just lowered our 1Q23/2Q23
Brent price forecasts to $90/95/bbl, respectively, from $110/bbl.

However, next year will see strong sequential demand growth (GSe 2.0/1.05 mb/d in
2023/24) from China’s reopening and recovering international travel. Alongside this is the
manifestation of a decade of underinvestment, with global ex US/OPEC+ production
declining through 2026. This will occur with stocks and spare capacity still near record
lows. Meanwhile, US shale faces bottlenecks, but more broadly, the industry has
matured, with a focus on shareholder returns, returning market power to OPEC (the Old
Oil Order). We therefore forecast Brent prices rising to $105/bbl in 2024.

The structural oil cycle has taken a pause this year. Spiking volatility and dollar strength
has led to financially under-invested markets, not dissimilar to the early 2000s. However,
despite numerous omens of underinvestment, we are yet to see a meaningful supply
response in rigs or capex. Meanwhile, upstream equities still reflect a high cost of
capital, disincentivizing growth, the opposite to the 2000s. Prices, and then equities, are
the leading indicator of a supply side resolution, as they ultimately conduct the capex
that results in rigs and, finally, production. This could be due to ESG constraints,
concerns on peak demand, or simply normal lags in the context of a high-velocity
post-pandemic cycle. For example, global capex did not meaningfully accelerate until
2005 in the last cycle, c.6 years after the cycle trough. Nevertheless, this lack of supply
response, in a weaker macroeconomic environment, and with financial underinvestment
in commodity markets, will likely make this cycle: longer, less extreme, but with higher
volatility, than in the 2000s, which also benefited from a significant tailwind in the
weaker dollar.
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MY TAKE:
> All of the upstream companies in our three model portfolios are in MUCH BETTER SHAPE since a year ago because of they used free cash flow to reduce debt. They are all now capable of funding drilling programs entirely with cash flow from operations. Access to capital is no longer an issue.
> OPEC+ now controls the oil price. I believe that they will not allow Brent to go below $80. As demand for oil-based products picks up this summer (as it always does), they will be slow to increase production allowing Brent go over $100 bbl.
> Weather is in control of U.S. natural gas prices. Even if GS is right about U.S. natural gas prices averaging $4.15 in 2H 2023 our gassers will have very good years. The long-term outlook for natural gas is very good.