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Bank of America makes case for oil prices above $100 per barrel

The odds of an oil price spike this year are much higher than the prevailing consensus in the market, according to a new report from Bank of America Merrill Lynch.

The oil market has been tightening rapidly this year, due to OPEC+ cuts taking supply off of the market, outages in Iran and Venezuela, and a slowdown in US shale. But forthcoming regulations from the International Maritime Organization (IMO) could provide an additional jolt, particularly as global inventories decline against the backdrop of a tightening market.

“Now, with distillate inventories at the low end of the range, we see an analogy to 2007/08 when the world run out of diesel refining capacity,” Bank of America Merrill Lynch wrote in a note on April 12.

“Back then, as Saudi Arabia lifted heavy crude production to meet rising global demand for distillates, diesel-to-bunker fuel spreads blew out and so did light-heavy crude spreads. A similar situation could develop over the coming months as ship owners temporarily up their distillate burn to transition out of high sulphur into ultra low sulpur bunker fuel due to the new IMO2020 rules.”

There are important differences between today and the price spike of 2008, Bank of America notes, including greater spare capacity in 2019, an additional 1.1 million barrels per day (mb/d) of refining capacity set to come online, and the expectation that US shale could quickly add supply in the event of higher oil prices.

“Still, unlike the gradual tightening in diesel markets of 2007/08, the world faces a major one-off jump in distillate demand,” Bank of America argues, referring to worldwide regulations on marine fuels set to take effect at the start of 2020.

The rules lower the limit of sulfur concentration in marine fuels from 3.5 percent to just 0.5 percent, which will force shipowners to switch away from heavy fuel oils. Instead, the alternatives include scrubbing technology and a greater use of low-sulfur fuels, including distillates.

Bank of America says that the regulations could push up distillate demand by 1.1 mb/d year-on-year, which comes on top of the 0.5 mb/d annual trend growth rate, and also on top of the cyclical high during winter. Higher distillate demand could push up crude oil prices as refiners race to turn crude into distillates.

“About 60 percent of the average crude barrel can be turned into distillate with the right refining toolkit. But that figure drops below 50 percent for heavy oil, potentially curbing supply,” Bank of America wrote.

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