From the Fuse

Bernstein warning not clickbait

Last week, Bernstein Research said that oil prices could hit $150 per barrel, breaking the all-time record of $147 in 2008. Analysts at the investment bank cite chronic underinvestment as the main factor that could increase prices to damaging levels.

“At some point the proverbial ‘chickens will come home to roost’. The impact will be production declines and another super-cycle in oil prices,” Bernstein analysts said. It would be easy for one to roll their eyes at the scenario, thinking that the $150 headline is a gimmick to garner clicks and attention. But we should start seeing that prices doubling from their current levels is a real possibility, one that might prompt widespread economic stress as the global economy is already dealing with turbulence amid escalating trade wars.

In 2005, Goldman Sachs said that oil prices were headed toward a “super-spike” period and would breach triple digits. Many commentators dissented at the time, suggesting that oil demand destruction would occur before prices could get that high. But prices kept rising and rising and rising. Demand did not fall off of a cliff once oil entered uncharted territory, and only began to decline when the housing market collapsed in the summer of 2008. Will a similar situation play out in the next couple of years?

The reasons why prices could hit $150 are well known and convincing—the OPEC cuts which are ongoing, unplanned outages that continue to stack up, extra thin spare capacity that is mostly concentrated in Saudi Arabia, and emerging market demand growth.

Supply going offline unexpectedly is biggest threat

Supply going offline unexpectedly appears to be the largest threat. Add Canada, Norway, and Gabon to long list of countries experiencing above-ground supply chaos. It’s clear that commercial stocks, after falling sharply due to OPEC’s supply agreement, and the Saudis’ roughly 1.5 million barrels per day (Mbd) of spare capacity along U.S. shale growth cannot meet demand growth, offset natural declines, and fill in the gap for unexpected outages, whether from geopolitics, weather-related events, worker strikes, or midstream limits.

Downstream constraints could play a role in heightening a crude spike

Risks are to the upside, and one overlooked factor—downstream constraints—could potentially put prices over the top to break 2008’s record. In 2020, new International Maritime Organization (IMO) rules take effect, significantly restricting the amount of sulfur contained in marine fuels.

At this time, ships still using petroleum will have to essentially consume diesel instead of dirty bunker fuels, straining the global refining system which is not yet prepared for the changes. Back in the mid-2000s, new sulfur specifications for on-road diesel and gasoline helped cause fuel prices to soar. The new regulations were a big win for improving air quality, but they caused price distortions at the time. What market participants tend to forget, is that the diesel market in the 2000s—with margins in certain regions hitting a massive $50 per barrel—was one of the main reasons pushing oil prices to their all-time high.

The IMO rules could have similar effects this time around, given that the bunker market makes up 5 percent of global oil demand.

All of this circles back to the demand-side initiatives, which are vital to mitigating risks of another price shock. Without stricter and modern fuel economy rules and continued strong financial incentives from governments to diversify fleets through electrification and other alternatives, consumers will remain vulnerable to price volatility and events outside of their control.

The coming months, and the next few years in fact, the oil markets will remain bumpy. It’s not inevitable that oil prices will hit $150, but there should be no surprises if they rally to that level, or higher.


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