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Did a Bullish Goldman Sachs Report Goose Energy Futures Again?

Some industry experts were wondering whether they were experiencing deja vu last week as the energy futures complex once again spiked following a bullish research report produced by global investment bank Goldman Sachs. While there were those who believed the 34-page report by the market leader was largely responsible for the price spike last Tuesday, others weren't so sure, with some noting that people are free to trade off of anything they want to.

In a report released last Monday to clients and subsequently obtained by NGI, Goldman Sachs analyst David J. Kostin said the energy sector has five bullish arguments versus only one bearish case, which equals a buying opportunity. The global investment bank oversees a multi-billion dollar energy futures portfolio.

After a fairly quiet session last Monday in energy futures that led to gains of 13.2 cents in November natural gas and 31 cents in losses for December crude, trading on Tuesday was a whole different story as energy futures spiked. On Tuesday Oct. 25, November natural gas charged $1.334 higher to settle at an all-time spot-month record of $14.338, while December crude gained $2.12 to settle at $62.44/bbl. The energy markets settled down on Wednesday with November natural gas recording a 29.8 cent drop and December crude settling $1.78 lower.

"Knowing about the report now really explains a lot about Tuesday's spike," said Steve Blair, a broker with Rafferty Technical Research in New York. "We really couldn't figure out what was going on. While it was cold in the Northeast, it wasn't far enough out of the ordinary to spike the market like we saw."

The broker noted that bullish news from a company with the reputation and sheer size of Goldman really could sway the market. "I think Goldman Sachs' reputation precedes itself. Their comments hold a lot of weight within the industry and the trading public. Would the market spike on that report, I have no question it would. I do also believe that any reaction would be a short-term phenomenon."

Blair said there was a lot of commission house paper on the Nymex trading floor Tuesday. "There was also quite a bit of fund activity. I don't know whether they were putting longs on or getting out of shorts, but everyone I spoke to on the floor Tuesday said the local traders were jumping in front of everything. When the brokers in the ring who handle the paper were doing the buying, the locals were jumping in front of them."

In the Goldman Sachs report, Kostin said the bullish arguments for the energy sector are:

On the other side of the fence, he noted that the bear argument rests solely on a "demand destruction" thesis, which he believes is "misplaced" concern. He noted that his counterarguments to demand destruction supporters is that demand decline has been largely involuntary. In addition, he said Goldman Sachs expects supply to remain tight as significant refining capacity remains off-line.

Blair said he agrees with Kostin's view on demand destruction. "I think when you have the hurricane, you have some immediate demand destruction," the broker said. "However, the world goes on. The demand destruction scenario in my opinion is overplayed in this market."

Kostin and his team said expected shortfalls suggest oil and natural gas markets are likely to tighten. "Significant supply remains off-line in the wake of Hurricanes Katrina and Rita," Kostin said in the report. "With more than 5 million barrels per day of production still shut in, a cumulative total of 325 million barrels has been off-line roughly six weeks after Hurricane Katrina first made landfall."

He added that U.S. distillate and natural gas will be "exceptionally tight" this winter even assuming a normal winter. "It seems there will be a certain amount of required distillate demand reduction simply because the current path of inventory appears to fall well below the minimum level necessary to maintain operations," Kostin said.

The bullish Goldman Sachs report followed by a bullish reaction in energy futures is not a new occurrence. In late March 2005 (see NGI, April 4), a Goldman Sachs research report warned investors that the oil markets are entering into a "super-spike" period that could see crude prices as high as $105/bbl. In addition, the firm said Henry Hub natural gas prices could soar to $13/MMBtu by 2007.

After the report hit the street March 31, the energy futures complex popped higher. At one point during that session, May crude and May natural gas were higher than the previous day's settles by $2.11 and 28 cents, respectively.

Looking at trading on Tuesday Oct. 25, IFR Energy Services Tim Evans said he did not lend a lot of credibility to the idea that the report moved the market. "Even if it did, people are free to trade the market on any little silly thing they choose to, whether it be tea leaves or an investment bank report. You have to remember it was much colder than normal in the east for two straight days. I also thought the natural gas move Tuesday was exaggerated by the approaching expiration of the November contract."

Evans noted that many of these factors are outside of the actual fundamentals themselves. "The Goldman Sachs report itself is not a fundamental; it is a view of the fundamentals, one that I believe is not a compelling view," he said. "The question comes down to what is Goldman selling? Yes, Goldman wants more people to buy their index funds, but they also don't care whether those people actually make money or not. They are in the business of selling the fund."

The analyst said the natural gas futures market is currently embroiled in a "valuation mess" that it can not seem to get out of. He blamed the growth of the paper market for the situation. "Nymex open interest in natural gas is 40% higher than it was a year ago, so the paper market is 40% bigger," he said. "Do you think the physical market is 40% bigger? I don't think so. I believe it is about the same size as a year ago. That flow into the paper market is what has driven the price up here, it is not a physical gas shortage, as evidenced once again by the bearish 77 Bcf storage injection report on Thursday."

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