What Could Move Oil Prices from Here?

In the wake of Hamas’ attack on Israel in early October and the Israeli government’s military response, the oil complex has emerged as a main risk to the global economy and markets today. We sat down with two of AllianceBernstein’s best minds when it comes to the energy sector, exploring their thoughts on the backdrop for oil and the balance of risks:

• Bob Brackett is the Senior Analyst covering North American Oil & Gas Exploration & Production for Bernstein Research
• Jeremy Taylor is a Senior Research Analyst and Portfolio Manager for AllianceBernstein’s Value Equities team and is responsible for research coverage of European commodity stocks

Note: This transcript has been edited for clarity and readability.

Thank you both for joining us today. How has the supply backdrop for oil evolved over the past year or so, and in your base case, what does that look like over the next year?

Jeremy: The supply picture has been benign, with slightly less disruption than we would have anticipated for the year. Russia was very much the risk that didn’t materialize. We did see slightly more supply growth than we’d expected from the world outside the US, but that was about it.

Bob: The industry continues to underinvest in oil and gas development. You can see that in a couple ways. You can build models, or you can just look at the mid-cycle price and see that it’s higher than it’s been for the past five years—even after releasing millions of barrels from the Strategic Petroleum Reserve.

The offset of the supply side from Russia has been a softening of sanctions on Iran, which added around 500,000 barrels/day of supply. (For context, global oil consumption is around 102 million barrels/day.) 

Longer term, how are you thinking about the oil supply picture?

Bob: Over the long term, supply will equal demand. The big moving part in the past decade was US shale. That’s less important going forward due to finite inventory and small productivity losses as we move from the best reservoirs to those that are harder to extract. So, we’re looking away from the 9 million barrels/day it’s added this past decade and see a shift in supply over to the OPEC+ countries.

Jeremy: We think about it similarly. There’s more uncertainty in the longer term around the demand profile. Supply will react to that. Overall, nobody is looking to significantly increase capacity in order to take market share in this environment.

Where’s the “swing barrel” of supply coming from these days?¹

Bob: We think of the marginal barrel as having to fulfill two criteria: being relatively high cost and being reactive to price increases. For instance, Mexico is high cost but not responsive. Shale was the swing player, but not anymore. Now it’s more the Saudis.

You can think of the mental model for that supply as whether a producer decides to expand an onshore megaproject—that kind of supply expansion takes a year or two to respond. These are only going to come online if producers have some degree of confidence in higher prices.

Jeremy: The rig count in both the US and Middle East is a good marker of where supply’s responding. You can see the responsiveness in the Saudi rig count, which fell from 60 rigs pre-pandemic to fewer than 30 rigs in 2021 and is now back up to 43 rigs as of October.

On the demand side, where do things stand today and what are you watching to gauge where they’ll go over the next year?

Bob: A couple years ago, we anticipated more discipline from the shale players and took a positive view on the entire sector based on rising oil prices. That's really played out and so we wanted to get a little more subtle going forward. What we're looking at now is a slower demand-growth environment. 

We thought we'd get to around $100 oil this year and we basically did. On the demand side, there are a few near-term issues to worry about:

• Seasonality, as Q1 is always the weakest
• The shift from extremely strong demand growth to normal demand growth (demand this year grew around 2 million barrels/day; next year that will be closer to 1 million barrels/day)
• Recession fears—take your favorite flavor and there’s the risk of that.

Jeremy: That’s the way we’re thinking about it, too. That trend rate of growth could maybe fall to 800,000–1 million barrels/day. We’re cautious on what the 2025–26 trend rate of growth would be. And if we do experience another period of robust economic activity, we expect to see the supply and demand balances in tension in the oil market again. There's a persistent tailwind for oil prices in that kind of environment. 

How has the situation in Israel affected your outlook?

Bob: It’s unclear how this situation will play out in relation to the oil markets. Iran has proxy agents fighting now, but does it expand to where [Iran] becomes directly involved? It’s hard to put probabilities on it. The price of gold has appreciated by around 10%, when it should be falling given where we are in the rate cycle. That tells you there are real fears.

But an escalation and subsequent oil market impact isn’t our base case. It’s not clear, even if escalation were to occur, just how far oil would go, let alone whether oil stocks would rise on it.

Jeremy: We see the conflict as a tail risk at the moment. There’s the probability of it, the uncertainty around whether that geopolitical event would actually occur, then additional uncertainty as to how energy stocks would respond to that situation. Do all equities just go down in that environment? Some stocks have more exposure to the Eastern Mediterranean than others, but we weren’t really interested in those names for other reasons prior to conflict breaking out.

Geopolitically, what do you see as the best case versus the worst case if the conflict does escalate?

Jeremy: There's a risk to tankers in the Persian Gulf. At the extreme, it becomes impossible to take tankers through the Strait of Hormuz (where 60% of oil travels), but that’s a super low probability event. It would take a threat from Iran to make any of that happen and it’s clear the US is trying to avoid that at the moment.

Bob: Demand destruction comes into play when fuel spending begins to hit 4% of global GDP. Back in the Iran-Iraq War, that’s when the oil price capped out. And at that time, equities didn’t participate that much—they rose a little, then faded. The US and Chinese navies are both in the Mediterranean right now and it’s one of the few places in the world they’re both aligned—neither wants a disruption of oil.

What major events or milestones do you have your eyes on in the Middle East in terms of escalations that would start to affect the oil picture?

Jeremy: The first thing would be a direct confrontation between Israel and Iran, likely triggered by conflict between Lebanon and Israel. On the flip side would be any reduction in intensity in the Israeli response in Gaza.

Bob: The globe’s engaged in a lot of proxy wars in a lot of places. The trigger for a real impact on oil would be a direct war instead of a proxy war. If that were to change—and we see a marked escalation from where we are right now—that would be something to watch.

Concluding thoughts: The recent conflict in Israel and Gaza has raised concerns about the impact on the oil complex and the threat it poses to the global economy and markets. Despite this, the supply of oil has remained relatively stable, with no capacity taken offline and no moves by major players to take market share. While the supply and demand for oil are both expected to grow in the future, the most significant “market-moving” question has shifted to the potential for a direct confrontation between Israel and Iran.