Bernstein: Oil May Jump Past $150 On Chronic Underinvestment

Authored by Tsvetana Paraskova via,

A supply shortfall is lurking should major oil companies continue to underinvest in exploring for new oil reserves, and this “chronic underinvestment” is setting the stage for the next super-cycle that could see oil prices soar to $150 a barrel or more, analysts at Sanford C. Bernstein & Co said on Friday.

Investors clamoring for cash returns on their investments in lieu of increased capital expenditures may soon backfire, as new oil reserves may be unable to keep up with demand, according to Bernstein analysts.

“Investors who had egged on management teams to reign in capex and return cash will lament the underinvestment in the industry,” the analysts said in a note, as carried by Bloomberg.

“Any shortfall in supply will result in a super-spike in prices, potentially much larger than the $150 a barrel spike witnessed in 2008.”

“If oil demand continues to grow to 2030 and beyond, the strategy of returning cash to shareholders and underinvesting in reserves will only turn out to sow the seeds of the next super-cycle,” said Bernstein.

“Companies which have barrels in the ground to produce, or the services to extract them, will be the ones to own and those who do not will be left behind.”

After the oil price crash of 2014, oil companies slashed exploration capital expenditure. Now that oil prices have recovered, those companies are looking to reward shareholders with dividends and share buybacks to show that they have successfully come out of the price slump.

The lowered capex in exploration, however, is depleting the oil industry’s reserves and reserves replacement ratios. According to Bernstein, the reinvestment ratio in the industry is the lowest in a generation, which is setting the stage for a super-spike in oil prices; prices may even beat the record of $147 a barrel from 2008.

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ZH: It's not just Bernstein that is fearsome of this kind of squeeze. BofA's Global Commodity Research team see a $50/bbl premium (i.e.around a $120 price for WTI) in the shorter-term if Iran is fully cut off.

Trump may consider reducing Iran oil exports to zero...

President Trump announced back in May that the US would unilaterally pull out of the Iran nuclear deal and re-impose sanctions on Iranian oil exports. Yet, Iran represents about 5% of global oil supplies. Can the US Department of State avoid issuing waivers to some Iran oil importers? In our projections, we have just factored in a 0.5mn b/d reduction in Iranian output rather than the widely discussed "zero tolerance" policy. This is because we believe a complete cutoff of Iran exports would send oil prices up sharply just ahead of the US midterm election.

Moving from a 0.5mn to a 1mn b/d Iran export curb would push Brent prices up by $8 to $9/bbl, on our estimates. In our view, US sanctions could prove ineffective if rising oil prices largely make up for any lost Iran volumes.

...but Saudi has never pumped more than 10.6mn b/d

So could King Salman instruct Saudi Arabia to increase production and make up for any missing Iranian volumes? Perhaps. But going back to 1970, we observe that the highest annual average production recorded by Saudi was 10.4mn b/d in 2016. More recent history shows Saudi has never produced more than 10.6mn b/d on average over a single month.

And even in the recent period, we have observed a steep decline in domestic Saudi oil inventories. Thus, it appears the oil market has little confidence that Iran volumes can be easily replaced. Of course, dealing with a new set of Iranian crude oil export restrictions would be easier if other ailing OPEC+ deal members like Venezuela, Libya, Angola, Mexico, or Nigeria were able to simply maintain their production levels.

If Saudi can't fill the gap, demand may have to slow

With OECD oil inventories coming down and the oil market poised to remain in deficit, the core question here is if Saudi can fill the gap as the US increases the pressure on Iran. Alternatively, we may just face an episode of oil demand destruction, although a strong USD backdrop could set a lower oil price cap. In different words, it may be hard to see Brent trading a lot higher than $100/bbl if the EUR drops to 1.12, as our FX team expects.

How high could oil prices go from here? It may be complicated politics, but it is simple math. We estimate that every million b/d shift in S&D balances would push the oil price by $17/bbl on average. So based on those assumptions, we estimate zero Iran exports could push oil up by $50/bbl if Saudi caps out. We expect in this game of chicken, someone will blink before that happens.