Goldman Sachs: Oil @ 30 bbl by March 2009

The continued deterioration in global oil demand has
compelled us to again lower our oil price outlook for
2009 to an average of $45/bbl from $75/bbl previously,
though we see a growing number of signs that oil
markets have entered the bottoming phase of the cycle.

Despite our lowered oil price deck, this is not a call
that we are incrementally more bearish on Energy
equities. Our global energy team is, however,
continuing to stick to a defensive posture within the
Energy sector in terms of our top picks, though we
have gained comfort in recommending select higher-beta
stocks that we might call
“offensive defensive” ideas (primarily hedged E&Ps
with transformational growth opportunities) .

We think a move back to high-beta names that would
benefit from a future rally in oil prices is still
several months away, pending greater confidence that
demand is no longer deteriorating and supply is
on-track to decline sharply. The latter we think
requires a longer period
of oil around $40/bbl (or lower) than we have
currently seen; demand globally also shows no signs of
improving.

We think that the sharp and sudden collapse in global
oil demand exceeds OPEC’s ability to, on its own,
balance markets,
and necessitates sharply lower non-OPEC crude oil
supply.

Unlike OPEC, we believe non-OPEC producers will reduce
production
and sharply cut capital spending only if cash flow is
sufficiently weak, which we believe is the case at oil
prices in the $40-$50/bbl
range.

However, because there is a lag between capital
spending cuts and evidence of lower production—and
demand is incredibly
weak right now—oil prices may need to fall further to
levels that stimulate non-OPEC producers to accelerate
activity declines and
possibly even shut in production, which we think will
occur at oil prices around $30/bbl.

While global oil demand is very weak and the duration
of demand weakness is unclear at this time, we believe
oil supply will
collapse if prices remain below $40/bbl for an
extended period of time (6-12 months or longer)
suggesting we are likely to have entered the bottoming
phase of the cycle.

• Oil prices are now meaningfully below the $60/bbl
level at which the average company earns a
cost-of-capital return on longterm
investments based on current costs; capital spending
reductions have begun.

• Oil prices have traded near the $40/bbl level below
which we think short-cycle activity will be sharply
curtailed, which should
accelerate near-term declines in supply.

• Industry returns on capital are near historic trough
levels at a $45/bbl WTI oil price.

• The WTI forward curve is in “super contango” that
historically has coincided with the weakest portion of
the cycle.

What is not clear yet is how long the bottoming phase
will last. Global economic conditions are the weakest
the world has seen since at least the early 1980s and
global oil demand is declining at an accelerating
rate. In our view, the duration and depth of the
downturn will be decided by the interplay of global
oil demand weakness and non-OPEC supply declines.

Global oil demand has weakened to the point that OPEC
cuts alone are unlikely to return the market to
balance, with greater declines in non-
OPEC supply now required.

In terms of gaining confidence that a bottom is at
hand and a recovery possible, we would need to see the
following:

• Demand: A deceleration in the rate of global oil
demand declines is critical (no signs yet).

• Non-OPEC supply: A sharp reduction in short- and
long-term capital projects is required (early signs
emerging).

• OPEC supply: It will be important for OPEC to
announce additional cuts at its December 17, 2008
meeting in Oran, Algeria in order to gain confidence
that OPEC’s “Big 3” of Saudi Arabia, Kuwait, and UAE
are on-track to reduce production by the 2 mn bbls per
day.