Bernstein: There is one reason to be bearish on crude oil, but ten reasons to be bullish.
The current crude oil market is in an extremely divided state: consensus is extremely pessimistic, yet fundamentals are surging beneath the surface.
Bernstein bluntly points out in its latest report that there is indeed a huge bearish rationale in the market right now—oversupply. Weak demand from China, the lifting of OPEC production cuts, and strong growth in supply from non-OPEC countries led to an increase of over 400 million barrels (over 1 million barrels/day) in oil inventories last year. As a result, market consensus has dramatically lowered expectations for oil prices in 2025, with some analysts even predicting Brent crude will fall to $61 per barrel in 2026.
However, this is exactly where contrarian investors find their opportunity. Bernstein believes that while the market is focused on short-term supply-demand imbalances, it ignores ten key pillars that support long-term oil prices. For investors with patient capital, the current price of $60-65 per barrel is unsustainable for the industry, capital is fleeing, and this is often the clearest signal of a cyclical bottom. As the old saying goes: low oil prices are the cure for low oil prices.
Return on capital has fallen below cost of capital, industry unsustainable
At current oil prices, the industry’s return on capital employed (ROACE) is shockingly low.
Bernstein calculates that the oil industry needs an average oil price of $50-55 per barrel to break even. If the oil price stays at $60 per barrel, capital returns for the industry will be only in the low to mid single digits.
Looking back at history, when oil was $64 per barrel in 2019, capital return was only 6%; with an average oil price of $81 per barrel in 2024, returns only reached 11%.
Given that the industry’s average capital return for the past 100 years is about 10%, the current low returns mean capital is flowing out of the industry. According to the cyclical investing playbook, when capital returns fall below the cost of capital and capital begins to leave, it is the best time for investors to get in.
Long-term oil price expectations have fallen below marginal production costs
Oil stocks reflect not the current price, but discounted cash flows based on long-term oil price expectations. The current 5-year forward price for Brent crude is $66 per barrel, which is too low for the industry.
Bernstein estimates the long-term marginal production cost at $71 per barrel. When the oil price is below the long-term marginal cost, the probability of positive returns from investing in oil stocks increases significantly.
This does not mean oil prices won’t go even lower in the short term, but the odds are tilting in favor of investors. In addition, as metal and material prices rise, marginal costs of production will only increase, not decrease.
China’s demand is slowing, but the “Global South” will take over the growth baton
The market generally believes China’s “golden age” of oil demand has ended: diesel demand is down due to economic slowdown, and electric vehicles now account for 60% of total auto sales.
However, Bernstein thinks the story of global oil demand is far from over.
Although oil demand in OECD countries and China may peak, outside China and OECD countries, the “Global South”—countries in Southeast Asia, India, the Middle East, and Africa, with a population of 5 billion—only consume a small fraction of oil per capita compared to the West.
Their desire to improve living standards will drive energy consumption, becoming the new engine for oil demand growth in the next decade.
Insufficient idle capacity buffer, risk premium should rise
Commercial oil companies produce at full capacity every day, with the only buffer coming from OPEC’s idle capacity.
Although OPEC lifted its 2-million-barrel-per-day production cut last year, causing oil prices to fall, it brought effective idle capacity back up to 3.4% (just over 3 million barrels/day).
This level is merely back to the historical average, equivalent to Iran’s output. It means that, in the face of unforeseeable war or supply disruptions, the global market’s shock-absorbing buffer is not thick. Therefore, oil prices should contain a higher risk premium.
Geopolitical risk is at multi-decade highs
History shows that wars in the Middle East often coincide with shocks to oil prices.
Today’s geopolitical risk index is higher than at any time since 9/11. While this does not necessarily mean a major conflict is imminent, a more fractured world undoubtedly increases the probability of supply disruptions.
The market’s optimism regarding Venezuela and Libya’s capacity recovery may be overly naïve; a high geopolitical risk environment supports higher oil prices.
A weak US dollar is a tonic for oil prices
Data from the past 30 years shows a strong negative correlation between the US Dollar Index (DXY) and real oil prices.
A weak dollar not only benefits emerging markets—new engines of oil demand—but also makes oil priced in non-dollar currencies cheaper, stimulating demand. As the US Dollar Index shows signs of weakness, this is bullish for all commodities, including oil.
Reinvestment rate plummets, reserve lifespans shorten
Reserve lifespan is the best leading indicator of long-term output growth.
In the past 25 years, proven reserve lifespans for the world’s top 50 oil giants have dropped from 15 years to 11 years. The main reason is low industry returns; companies focus more on shareholder returns (buybacks and dividends) than on capital expenditure.
The industry reinvestment rate (ratio of capital expenditure to cash flow) has plunged from nearly 100% to about 50%. This lack of investment means weaker future reserve replacement and headwinds for future output growth.
The energy sector’s long-term underperformance offers contrarian value
In the past 11 years, the energy sector only outperformed the S&P 500 in 3 years, and has lagged for 3 consecutive years. The sector’s weight in the S&P 500 has plummeted from 12% in 2011 to just 3% now.
Investor interest is at rock bottom, but this is the contrarian opportunity. Oil tends to operate in super cycles; while we may not be on the verge of a new super cycle, before demand tops out, the industry could still see another major cyclical rally.
The golden age of US shale oil is ending
Over the past 15 years, explosive growth in US shale oil output (from 5.6 million barrels/day in 2010 to 13.5 million barrels/day) has reshaped the global landscape.
But this “golden age” is ending. Major basins like Eagleford and Bakken are now in mature phases, and even the core Permian basin’s top-tier blocks are nearing exhaustion, with signs of output growth peaking.
The current consensus is that US crude output will stay roughly flat compared to last year’s record. Rig counts will keep falling in 2025, and if WTI stays at $60 per barrel or lower, rig counts will drop further. This means the supply growth engine from non-OPEC countries has stalled.
China’s strategic petroleum reserve (SPR) build-up
Despite weakness in China’s industrial demand, SPR buying is providing substantial support.
Last year, China added over 100 million barrels to inventories, with another 150 million expected this year. China now has about 1.4 billion barrels in reserve, equivalent to 112 days of import cover.
More importantly, the macro logic has shifted: China has huge trade surplus funds. With gold prices expensive (over $5,000/oz), oil has become a better reserve asset. If oil stays below $70 per barrel, China has every reason to keep absorbing physical crude through strategic stockpiling.
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The above highlights are from Chasing Wind Trading Desk.
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