Rory Johnston on How Oil Could Surge to Over $200 a Barrel

Oil has obviously spiked massively since the start of the war with Iran. And if you look at various end products, such as jet fuel, the surge is even more extreme. And if the war is prolonged, or if the Strait of Hormuz continues to be functionally blocked, then this could just be the start of an even bigger spike. On this episode, we speak with Rory Johnston, the author of the Commodity Context newsletter. Rory is typically a very level headed guy, and not a doomer at all. And even he is quite alarmed. He says that the persistent closure of the Strait of Hormuz is such big disruption to contemplate that it’s typically used as the worse case scenario in industry thought experiments. He walks us through how oil could go to $200 a barrel or beyond, resulting in higher prices at the pump for American consumers, and perhaps significant shortages in the rest of the world. Read more:Trump Signals Possible End to War, Floats Removing Oil SanctionsVenezuela Oil Buyer Says Its Cargo Is Sailing to Caribbean Only Bloomberg - Business News, Stock Markets, Finance, Breaking & World News subscribers can get the Odd Lots newsletter in their inbox each week, plus unlimited access to the site and app. Subscribe at bloomberg.com/subscriptions/oddlots Subscribe to the Odd Lots NewsletterJoin the conversation: discord.gg/oddlotsSee omnystudio.com/listener for privacy information.

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• 0:00Tracy Alloway?

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• 1:52Speaker 01

  Bloomberg Audio Studios. Podcasts, radio, news.

• 2:08Joe Weisenthal?

  Hello and welcome to another episode of the Odd Lots Podcast. I'm Joe Weisenthal.

• 2:13Tracy Alloway?

  And I'm Tracy Alloway.

• 2:14Joe Weisenthal?

  Tracy, did you see that oil is already technically in a bear market?

• 2:19Tracy Alloway?

  I did. I did. So I think the definition of a bear market is down, is it 10 or 20%?

• 2:25Joe Weisenthal?

  20%.

• 2:25Tracy Alloway?

  I can't remember now.

• 2:26Joe Weisenthal?

  10% is a correction.

• 2:27Tracy Alloway?

  That's right. Okay, so it's down 20% from the high of, I think Brent, was it something like 120 per barrel?

• 2:35Joe Weisenthal?

  Almost 120, 119.50.

• 2:38Tracy Alloway?

  So yeah, it's coming down. However, it's still up quite a bit from where it was like a week ago.

• 2:45Joe Weisenthal?

  Oh, yeah, absolutely. I mean, it's still up 8% from Friday. I mean, that's how crazy the oil market is right now.

• 2:52Tracy Alloway?

  We're at that moment in time where numbers kind of lose all meaning, I feel, right?

• 2:57Joe Weisenthal?

  Yes. And obviously, look, we all know the context, just extraordinary surge. I think one of the things that's surprising to me, or not, maybe not surprising, but notable to me, and we'll get into this with our guest, of course, in a minute, is that Iran war risk was well known. The price of oil had already been creeping higher a bit, even prior to the first attack. So this was already a concern, but it sort of goes to show like how, I don't know exactly what the term is, how unexpected, or the degree to which basically this was not priced in, the fact that traders were already very keen and aware that there was a very high possibility of a strike in Iran.

• 3:39Joe Weisenthal?

  And yet, we've just seen this absolutely massive surge in just the span of, you know, 10 days, really.

• 3:46Tracy Alloway?

  Well, the other thing that's happening now is because we had pretty good oil supplies out there at the beginning of the year, that's kind of become, I guess, a vulnerability because you had a lot of oil in floating storage, for instance. But that means now the floating storage is filled and it can't go anywhere because you can't get through the Strait of Hormuz. And therefore, all the new production is getting shut in a lot faster than it would be. Otherwise. So it feels like some of the buffers that we had are kind of turning into, I guess, vulnerabilities.

• 4:19Joe Weisenthal?

  Yeah, totally right. Now, the thing with a lot of commodity people is that, and I love them. So this is, but the thing, no, but a lot of them are like, sort of, I don't know, like perma doomers, like sort of a little bit crankish, a little bit more always thinking about risks and so forth, and ways that things could go bad, and how it could go back to the Stone Age if we don't have the free flowing commodities of all sorts. And again, I love them all. But someone else pointed, I forget who tweeted it over the weekend, but they said, like, even the least alarmist, I think it was, might have been Stinson Dean, actually. He said, even the least alarmist people in the commodity space are very alarmed right

• 5:00Joe Weisenthal?

  now. And so, yeah, people are talking about this being one of the worst oil shocks ever. I mean, it's very extreme.

• 5:07Tracy Alloway?

  Joe, if you worked in an industry whose lifeblood was the liquefied remains of prehistoric organisms, and there was a finite amount that you knew one day was going to run out, you'd be a doomer, too.

• 5:18Joe Weisenthal?

  You're right. Well, we're going to be speaking with someone who is not a doomer. Overall, very pleasant fellow, but someone who is quite alarmed, who thinks that oil could actually go to $200 a barrel quite plausibly, depending on how the war unfolds. I'm very excited. We haven't talked to him in a while, but an Odd Lots favorite here. We're going to be speaking with Rory Johnston, founder of Commodity Context, all around oil nerd. He even teaches at the University of Toronto. So Rory, thank you so much for coming back on Odd Lots.

• 5:48Speaker 03

  Thanks for having me back, guys.

• 5:50Joe Weisenthal?

  Let's start with this idea that Iran war risk was already very much on the radar of traders long before the strikes. The price had been creeping up. And now we've seen this huge surge. So we were at about, I'm looking at the Brent chart, we were just over $72 a barrel the weekend before the attack, currently right around 100. What has happened in the last, you know, just over a week that's been so far beyond what traders might have been anticipating?

• 6:21Speaker 03

  Yeah, so I think you very kindly described me as a reasonable person. I agree that I think a lot of people in the commodity space have a kind of a perma-bullish bias. And I think for many of the reasons Tracy mentioned, when I first got into the industry, I was very much like that, oh, my goodness, ISIS took Mosul in Iraq in 2014. We're going to crazy levels. But I think what we've discovered and what's been reinforced repeatedly over the past half decade is just how flexible and resilient the oil market is. We've dealt with everything from COVID to Russia's invasion of Ukraine, to Houthis in the Red Sea, to full-blown attacks with Iran and Israel last year. It's gone through a lot, and despite that, the market has been shockingly, shockingly resilient.

• 7:05Speaker 03

  These were all the things that we used to kind of stress the market with. But I think the difference is, I think this is kind of almost, in some ways, the market's gotten used to the wrong lesson here. Rather than being doomers, we've gotten overly sanguine because the market is able to fix all of these problems. And I think the market is shockingly, shockingly good at this. But this is one of those problems. The closure of the Strait of Hormuz is something that can't really be fixed by markets. It's so large and so physical. And you had kind of mentioned like why this kind of confounded expectations. You had mentioned, so, you know, over the prior month or so, we had built in upwards of $10 a barrel, largely of Iran risk, mostly from speculative participants kind of anticipating this. And again, it wasn't a secret. We had the largest buildup of US military personnel and equipment in the Middle East

• 7:50Speaker 03

  since the invasion of Iraq in 2003. But them, like myself, I never expected this to happen. I never expected to see this particular shock in my lifetime. This was the kind of, this is the scenario that you give new analysts in the industry as kind of a thought experiment of, okay, if this happened, how would everything break? Because I think it's actually a very illustrative and educational thought experiment. It's terrifying to be kind of speedrunning it in real time.

• 8:17Tracy Alloway?

  So on this note, when something like the events of the past week happen, how much of an oil analyst's job is actually thinking about supply chain adaptations and where oil could get rerouted versus just thinking geopolitics and becoming an armchair military expert and thinking like, well, this is when the conflict might actually end?

• 8:41Speaker 03

  I think it's more on the supply chain. And I think when we as our airlines like look at charts and data, what we're really trying to do is both, I mean, honestly, to understand, you know, and see where the price of oil is at any given day, but more kind of looking at what those signals tell us about what's happening in the underlying market. And when you have such a massive dislocation like we're facing right now, none of those signals act like they usually do. They're all flying in all different directions in crazy fashion because this is such a massive, massive loss. And just again, just to put in perspective for people what we're talking about, because someone that's not aware of the market saying, oh, well, 20% of the market, 20 million barrels a day that flow through Hormuz, yeah, that's, we could deal with that, right?

• 9:22Speaker 03

  But that's actually, so 20 million barrels is the peak of COVID demand loss in March and April of 2020. That was when we were all locked inside, when airports were empty and planes were grounded. That was the type of demand destruction that 20% looked like. And now, if the straight remains closed, and I think this is the critical part here, whether it's the war or whatever, and we could talk about all the ways that this could, you know, the nuances and the way you got, you know, slippage and leakage, but if the straight remains as it is today, we will need to forcibly kind of adjust the market to that level of demand, but without a pandemic, just via price signals. That's why 200 plus is at least, I mean, the longer this goes on, the higher we go. And it's not just oil.

• 10:06Speaker 03

  We had already seen jet fuel in Asia hit over $200 a barrel briefly, because the product markets are the things that are actually going to drive that demand destruction, not crude itself.

• 10:15Joe Weisenthal?

  Yeah, explain that a little bit further, the product markets. Talk to us a little bit, when you say that, what do you mean by that?

• 10:24Speaker 03

  Yeah, so you and I as global consumers don't actually typically consume crude oil.

• 10:29Joe Weisenthal?

  Only Tracy does. Only Tracy does.

• 10:32Speaker 03

  Tracy, Tracy does, exactly.

• 10:33Tracy Alloway?

  Unsuccessfully, but yes.

• 10:35Speaker 03

  I think, I think all of us would be pretty unsuccessful, kind of consuming very, very toxic liquid. But I think, you know, what we actually consume, jet fuel, diesel, gasoline, these are things that are created, distilled, and refined in a, in an oil refinery. So oil refineries consume crude. So what we talk about when we talk about the blowout in the product market is we're talking about. So crude oil has a supply and demand curve, as you'd see in Econ 101. And then each individual product, gasoline, jet fuel, diesel, naphtha, petrochemical feed, everything else, shipping fuel, they all have their own specific supply and demand curves, which this market becomes fractally complicated very quickly. But to simplify, really what we're talking about is a refinery taking, let's say, a barrel of oil

• 11:18Speaker 03

  for $100, which is roughly where we're trading right now. I'm Brent, we're kind of jumping on the other side of 100. They take a barrel of oil for 100 and they refine into a bunch of different products. The premiums they get for those products are what we typically call the crack spread or the difference between crude and a refined product that is yielded from a refinery. And the refinery margin is essentially the weighted average blend of all those crack spreads plus other costs and everything else. But what's happening right now and the reason that we're actually seeing the refined product market jump ahead of the consequences in the crude oil market is that the worst thing for a refinery is literally running out of crude feedstock. And actually, full credit to Jun Go of Sparta Commodities for educating me more on this because I would have thought, wow, product markets are going insane.

• 12:03Speaker 03

  Refineries must be chasing as hard as they can, running as fast as they can to capture those exceptionally high margins. But the issue is that for them, shutting down a facility is the worst case scenario. This is basically a giant flowing chemistry set. But if you turn it off, it's really, really hard to kind of turn back on properly and it takes a lot of time and money and downtime. And then you're not capturing any of those margins. So what the refiners are doing, these are the refineries in Asia that basically have a massive 20 million barrel a day gap coming towards them in the market in terms of feedstock. They're preemptively reducing activity, reducing the rate of runs so they can extend their runway basically for how long they can remain in the market at all. So this means that with crude oil, two weeks ago, we still had crude flowing out of the Gulf.

• 12:47Speaker 03

  It takes a month or two for those cargoes to get to where they're going. It's only then that we'll really start to feel the consequence and the supply loss and the inventory drain down. But with the refiners in Asia in particular, preemptively and kind of adjusting down their run rates, we're seeing the impacts in Asian product markets immediately.

• 13:21Tracy Alloway?

  There are some market stories where you want every detail. Joe and I have made quite a few podcasts on that basis. But sometimes you've only got 10 minutes and just want to know what's moving markets fast. That's the Barclays Brief Podcast. Every week, experts from Barclays Markets and Research get you up to speed on what's happening and what to watch next. Concise, focused, and brief. Search Barclays Brief wherever you get your podcasts.

• 13:48Speaker 04

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• 14:17Tracy Alloway?

  So the other thing I wanted to ask you about, Rory, is so we have strategic stockpiles that are supposed to help us get through these types of near term supply shocks and the release of which is supposed to not only push down the price of stuff like gasoline, but also maybe help the refiners keep going so that they don't have to start preemptively shutting down capacity. At the same time, we now have G7 countries that seem to be very reluctant to release from the stockpiles. And I should just mention that we're recording this on March 9th and there are all these headlines flying around. So who knows what will happen by the time this episode gets out. And then at the same time, we also have the US where there's a lot of chatter about releasing from the SPR.

• 15:01Tracy Alloway?

  Talk to us about the pros and cons of actually dipping into those strategic stockpiles right now.

• 15:07Speaker 03

  So I think it's important to note that like this is the mother of all supply risks. This is the boogeyman for every oil analyst when they're kind of learning the ropes. This is the purpose-built reason, the scenario precisely that the SPR was kind of created to mitigate the risk of. To me, it's insane that they haven't yet tapped the reserve already. And I think speaks to the fact that particularly Trump administration has tied itself in knots criticizing the Biden administration for releasing SPR stocks in 2022 to offset the Russian supply shock. Now, just on that very briefly, I was a big supporter of that release. I thought that was a clear national security threat and global economic threat that Russia posed when it invaded Ukraine. And we thought we were going to lose so much oil from Russia.

• 15:51Speaker 03

  But it wasn't executed perfectly in fairness, but still, I think that was a good purpose of it. And now, this is also a very good purpose of it. We could have refilled more in the interim, and we should have. Congress needs to allocate more money to the SPR, to the Department of Energy. Most of the money that was earned from the Biden-era sale of the SPR has essentially been remitted to Congress. So you actually need to get that money back again. But I think what we've seen, so this morning, the IEA and G7 countries were talking about this coordinated release of 300 to 400 million barrels. This is what the Financial Times reported, as I saw. But yeah, they come out and said, no. Now, there's a couple of reasons that you could explain why they could say no. One, they could be hoping and fearing that things are going to get even worse, so holding it, you know, closer to the chest.

• 16:37Speaker 03

  On that, I would say, one of the big problems is that the collective release rate of the SPRs around the world is not 20 million barrels. So the crisis is already really, really bad, and you can't actually fill the gap entirely with SPRs, even if it was unlimited, which it isn't. Just the flow rate itself can't keep up. So if anything, you kind of need to almost start easing earlier rather than later. On the other hand, I think there's this question of like, maybe, you know, repeatedly, we hear that like Trump thinks it's going to be a short-lived shock. Last night, when I was driving into Ottawa, you know, they were talking about, you know, this could be short, sharp, and then we're going to get rid of the Islamic Republic in Iran, and we're all going to be better off. But this is not, nothing, nothing that we've seen. So far indicates it's going to be short and sharp.

• 17:19Speaker 03

  Again, I'm shocked. We are this far down the road. I didn't think the president had the appetite for this kind of true and utter chaos. And we're going to see how long he remains to have the appetite for that. But that's essentially the best read I could have is they think this is short, a short-lived geopolitical sentiment disruption. When this is really just the largest physical supply disruption we've ever seen. The other thing they're reportedly musing, which is even more insane and terrifying, is renewing the export ban on both crude oil and refined products. Something that the Biden administration kind of mused about in late 2022. And I wrote a piece then on commodity context that was all about the reasons that that was a really, really bad idea.

• 17:59Speaker 03

  That I appreciate the impulse towards autarky, particularly given the fact that the United States is the largest oil producer in the world now. But not only are crude quality issues at play, you know, the US produces too much light and doesn't, and still needs to import heavy. But also there's regional issues that the US Gulf Coast is a net exporter of diesel. The US East Coast is a net importer of gasoline from Europe. So basically, if you start closing these borders off, all of these individual regions start to basically shut down and kind of ossify in a way that is not at all what I think President Trump would want. But I no longer have much faith that they are fully thought in this through because if you had, you would have thought about the SPR, you would have thought about insurance, you would have thought about all of this already, and they just clearly haven't.

• 18:43Joe Weisenthal?

  Yeah, this is one of the striking things to me, at least from everything I've read. There it sort of seems to have taken them a little bit by surprise, some of the mercury. I mean, it's almost hard to believe that there wasn't more anticipating of this when you're going into war like this. But it does not seem, I certainly get the same impression as you. By the way, everyone should pull up that chart of Singapore jet fuel prices. It almost looks fake. It's just like, you know, we're $90 a barrel at the end of February. Broke 220 recently. It's come in a little bit. So talk to us a little bit more about the sort of relationship between the duration of the war

• 19:26Joe Weisenthal?

  and the ability to flip the switch back because it does, the president's communication does seem to be like, yeah, we're paying a price right now, but it's going to be worth it and then prices are going to come down. How, you know, as this goes on longer and longer, to what degree does everything compound? And make it more difficult to go back to normal?

• 19:47Speaker 03

  And I think this is a topic that I was listening to actually your podcast on the Strait of Hormuz flow with the shipping experts exactly on this topic. And I think you guys nailed it there that this gets worse every single day it goes on. But let's talk through the ways it gets worse. So when we talk about the Strait of Hormuz, like you could think of it very simply as like the world's largest pipeline, or like a big giant garden hose, you know, through which 20 million barrels of petroleum flows. When the straight was closed initially, you know, for the first day, two, three days, it's kind of like a kink in the garden hose. If the conflict had ended then, which is honestly when I expected it to end, you would unkink the garden hose and things would get back to normal pretty quickly. Kind of no harm, no foul, some issues, but like you can make that up pretty quickly. But now, you know, 10 plus days into this, we now have the

• 20:31Speaker 03

  equivalent of a 200 million barrel air gap in the global flow of petroleum, first of all. Not to mention that in addition to this kind of kink in the garden hose, that pressure has built up because these countries can't export out of this region anymore. Countries like Iraq and Kuwait in particular, both of which lack sufficient domestic storage capacity because they're they just export the stuff all the time. And for for decades and decades, they have been forced to shut in production. Now, Iraq, as of yesterday, shut in over 3 million barrels a day of production from its southern Basra fields. That is alone, just Iraq alone so far. That is the same size as the feared loss of Russian supply in April of 2020, 2022, that sent the market, you know, ripping higher above

• 21:16Speaker 03

  120 Brent, just for perspective. And we didn't end up losing that supply in the Russia case. We only lost one briefly and it came back. But in Iraq, we've already lost Kuwait, we've already lost it. In the Emirates and Saudi Arabia, they have more storage capacity and a bit more optionality. They can get, you know, there's a pipeline to the West Coast in the Red Sea in Saudi Arabia that can divert some of the flow. Similarly, with the United Arab Emirates, you can divert some flow out the port of Fugira, the pipeline to the West Coast of Saudi Arabia can get bombed. If we get to an existential battle, you know, this keeps grinding, same with the ports of Fugira, I think. But again, these systems can all be broken. So you've lost that. So you've lost supply structurally, at least for weeks, potentially a month. Even if the thing resumed, even if flow resumed tomorrow.

• 22:00Speaker 03

  And then on the refi, that's on the exporter, the supply side, on the demand side and the importers in Asia. Like I said, you've already begun to lose refining runs. And because jet fuel is very particular, I think rightfully so. So you don't store as much of it typically. So I think part of that giant spike in fuel prices and jet fuel in particular was this sudden kind of loss of supply, not a lot of inventory cover. And all of a sudden you had all of these airlines all across Asia, it's like, wow, I'm not hedged for this. I need to get every barrel I can right now. So I think even if this resolved right now, which it doesn't look like it's going to, but even if it did, now we have a big air gap in the system that's going to need to work itself out. And all of these different supply chains will probably end up taking two, three months

• 22:42Speaker 03

  minimum to get back to something resembling normal. And it doesn't look like we're about to kind of resume flow to the state of her moods right now, despite what the White House says.

• 22:52Tracy Alloway?

  I have what is perhaps a silly question, but does demand destruction actually exist when it comes to higher oil prices? I mean, you know, seriously, I know that airlines will go bankrupt eventually because of high oil prices, but it feels like it is one of those things that you want to keep using for as long as you are physically or financially capable of doing so.

• 23:16Speaker 03

  I'll talk about three different angles here. So the first is the difference between the elasticity of price versus the elasticity of income. So I think there's the one question of, I think when we typically think about demand destruction, we think primarily through the lens of like, prices got too high, so I'm not going to drive to work today. There's also the angle of prices got so high, they crashed the economy and you lost your job, so you no longer have to drive to work. So that is one angle if this goes on for much longer. We're not talking, like, we're talking serious recession, if not like outright global depressionary conditions if the straight remains closed for a month plus, you know, two months. So there's, that's the one angle. But when we talk about, you know, I agree, I'm not going to stop driving my kid to school. I have a fairly high tolerance for high prices. But we live in wealthy, advanced societies.

• 24:01Speaker 03

  I think what you saw, for instance, in 2022, I think is illustrated this in the LNG market when there was a very, very high High-profile event when a contracted LNG tanker that was supposed to land in Pakistan got diverted and ended up in Europe because the Europeans were willing to pay way, way more. And basically, the LNG supplier broke the contract to service that, which economics dictated, but I think the human cost was very real. Pakistan just couldn't afford it. So what you're going to see here, let's say, again, in this horrible scenario, where the straight from us remains closed until 2027, this is what the world would look like. What you would end up seeing is massive demand destruction from lower-income countries that can no longer afford to get those barrels and attract them to their shores in the first place.

• 24:45Speaker 03

  So you and I would see this as massively surging prices at the pump, and we would grumble, and it would sap our consumer spending energy, et cetera, et cetera. But the barrels would likely be there. We are in the countries that will attract the most supplies because we're willing to pay the highest prices. But other lower-income countries in the world, it's not going to be a price issue for them. It's going to be an outright shortage. And that, I think, is how demand destruction in this particular instance would work.

• 25:26Speaker 04

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• 25:55Joe Weisenthal?

  Talk to us about $200 barrel. How do you, so this is in the cards, potentially. Can you walk us through the math of how we get there? Or like, why that seems like where it could go and not just, say, $150? Talk about how you, why that number seems realistic.

• 26:10Speaker 03

  Yeah, and I should say, I mean, like, 200 is, you guys kind of said in the intro, like, these are just kind of placeholder numbers at this stage. Like, the numbers stop meaning something when they reach that high. But just to this point that you're going to need to keep ratcheting the price or higher and higher and higher until a couple of things happen. So, one, even if this continues, even the war continues, a lot of this was predicated on this assumption that the straight remains completely shut. Important historical context is that even during the tanker wars of the 1980s, at the peak of the kind of Iran-Iraq war, when you had, I think it was over 450 ships attacked, 250 tankers, and like 50 of those tankers were either sunk or scuttled entirely, like a much bigger, more explosive situation than we're currently even seeing in the Gulf today. During that period, you never actually had a stoppage through the Strait of Hormuz.

• 26:53Speaker 03

  You had military escorts, you had other things, but the oil continued to flow. In this instance, it's effectively shut. You're seeing minor, like let's say 5% to 10% of the prior flow go through, but it's effectively shut. We've never really seen this before. So if this continues, you're going to keep bidding up prices to do one of either two things. We talked about demand destruction, so I think that's one way the market solves itself. Or prices get so crazy high on the other side of the strait. And the other thing I should note here is crude prices are probably effectively negative prices right now on the wrong side of the strait, because those are stranded barrels and no one can get to them. But if you can basically arb that between effectively negative prices and potentially the highest prices we've ever seen in the market, that's a really compelling economic incentive to take the risk to cross the strait

• 27:38Speaker 03

  or to pay your crews, you know, the sufficient amount of money to cross the strait or to afford the exceptionally extensive war insurance. So it's like that mad money meme, it's like that's what the money's for. It really is that we're trying to basically incentivize between two awful scenarios. Either seafarers and tanker owners risking their lives and their ships going through the strait to deliver this fuel, or you're asking people to basically stop moving, stop moving around the planet. And neither of those is a very attractive solution, which is why, again, I just fundamentally can't see this continuing. I think, I keep saying like Trump's gonna taco because he has to taco, and people keep criticizing me, they're like, no, no, it's no longer just Trump's call, it's Netanyahu, it's the Iranians, or whatever.

• 28:21Speaker 03

  And I think that's probably true, it's not just Trump's call anymore. But he's still, one, the person that's probably movable on this by market reaction. And two, he's still probably the most important incremental voice in that conversation. So if he pulled out, I think that does a lot to de-escalate the situation. I think that's probably where we need to go here.

• 28:37Tracy Alloway?

  I realize we have, I don't think we've mentioned OPEC once in this conversation, which probably says something about OPEC's relevance today. But you know, to what extent can OPEC respond with a big supply increase and maybe shift some production away from the Gulf and start firing up output elsewhere?

• 28:57Speaker 03

  Yeah, so I think it's a great question. And unfortunately, the Strait of Hormuz is a risk concept, kind of short circuits the OPEC's normal reaction. But we were talking about spare capacity. Virtually all the spare capacity in OPEC is on the wrong side of the Strait of Hormuz. It's in Iraq, Kuwait, Saudi Arabia, and the UAE. All of that is currently caught up in this. So I think that's part of the challenge and why the Strait of Hormuz was always the boogeyman scenario, was there's no real normal way that the market can get around it. The one major producer that's within OPEC plus, that is likely the single greatest beneficiary of this, is actually Moscow. So the Russians had been under increasing pressure during, you know, the administration had put a lot of pressure on all of the kind of what I call like the big sanctions three.

• 29:41Speaker 03

  You've got Iran, Venezuela, and Russia. Venezuela, we have a regime change. Iran, we're in the process of doing so, or trying to. And then in Russia, they said that they were prioritizing the war in Ukraine, and they were at various points. But now, they had actually been putting a lot of pressure on the Russian oil trade. India, which was one of the largest importers of Russian crude, largest seaborne importer of Russian crude after the invasion, with the price cap and everything else, they got under increasing pressure on two fronts. One, the Trump administration issued blocking sanctions, or like the hefty, you know, really, really tough sanctions that were on Iran, issued those on Rosneft and Lukoil, which are Russia's two largest crude oil exporting companies. In addition to that, so Indians didn't like that, and they started pulling back purchases

• 30:25Speaker 03

  there because they're afraid of the sanctions risk. But in addition, Trump actually imposed a specific punitive 25% tariff on India for being such large importers of Russian oil. So over that, kind of between October and say, January, we saw Indian imports of Russian crude drop from over 2 million barrels a day to about 1 million barrels a day. So they halved. That Russian oil wasn't really, it was a little bit going more to China, but it wasn't finding many other buyers. So Tracy mentioned that, you know, we are building up lots and lots of oil and water. That's where a lot of this was ending up. So the prices for these, the discounts that were kind of suffered by Russian barrels were exploding. They are building up on water. Russia was kind of, the oil industry was on its back foot and probably going to start contracting pretty meaningfully if that continued.

• 31:10Speaker 03

  Now, what are you seeing? Well, all of a sudden, one of the major places that has any incremental supply at all to share on the world is Russia. So India is back in the market for Russian crude and the White House actually explicitly gave them a waiver for those sanctions that I mentioned previously. So they're going to start importing a lot more Russian crude because they need to. And even the Europeans have started clamoring about easing sanctions or reopening flow on the Druzeba pipeline to Eastern Europe and into Germany. It's a mess. And again, it's a mess that overwhelmingly serves the interests of the Kremlin above any kind of other single national actor in this oil market.

• 31:49Joe Weisenthal?

  It is a pretty striking turn of events with that, isn't it? You brought this up earlier, but I feel like this is going to come up, so we should talk about it more. There actually was a headline already, this idea of curbing exports. And, you know, I think in a lot of people's head, it's like, oh, we produce more oil than we need, we export them, let's just keep it all at home and then prices will come down, et cetera. Like, I feel like if you're not thinking second order, it sounds like a totally fine thing. Walk us through like why you think that's like a disaster scenario.

• 32:21Speaker 03

  Yeah, so I think what would be compelling to Trump is that in the first two or three weeks, it would result in very meaningfully lower pump prices for US consumers. I think, let's just get that out of the way. But in a way that's kind of too much of a good thing, in that what you see is, like as an example of the US Gulf Coast, which is the major refining hub of the United States, where you have all of the outlet from the Permian and all the rest of the oil fields and directly into that refining hub, much of which is exported. You see a lot of diesel exports, about a million, million and a half barrels a day of diesel exports out of the region, largely going to Mexico, Latin America and other areas. If you ban exports, let's say across the board, what you would do is you would start building those inventories at that pace in the US Gulf Coast.

• 33:05Speaker 03

  So you would start overflowing your tanks of diesel. Diesel prices would crash. That would be great, very briefly, for your kind of, you know, drivers of big, your big diesel trucks and shipping, et cetera. That's great, but... Eventually, you reach the stage where it's the same kind of thing as you're seeing from the Gulf exporters. You run out of storage space and all of a sudden you can't produce any more diesel. You can't put it anywhere. That begins to overflow your tanks. You need to cut runs. That's when things get bad because then you're starting to lose gasoline supply. You're starting to lose everything else as well. And all of a sudden, you're going to get turned into an importer of various fuels. Now, there's also the issue that you have a lot of trade between regions that like, maybe you could put excess fuel out of the Gulf Coast into the East Coast. Ah, well, then we get back to your favorite

• 33:50Speaker 03

  topic, the Jones Act. So I think there's a way that you could design a very specific policy that was selective with certain fuels and everything else. If this was a true, like if Trump wanted to do this for months, then yeah, I expect him to do something along these lines and it's going to get extremely messy. I also don't know if they can kind of stick handle the specifics of this industry in the way that they would need to. But you could create a scenario that the US basically cuts itself off from the world and does so in a way that doesn't completely destroy the industry. So let's say you still allow US Gulf Coast diesel exports. But I think the other thing here is that over time, the system just continues to break and erode that all of those imports into the US East

• 34:34Speaker 03

  Coast, well, those barrels will get incentivized elsewhere. If you can't incent, like, let's say he goes full Nixon, ala the 1970s oil shocks. And not only do you have an export ban, let's say you have price caps or price fixing at the pump, not outside the realm of possibility with the current administration. I think that is where, again, you short-circuit that mechanism I mentioned earlier, that in the current situation, we likely, in the United States, Canada, where I'm up right now, these countries likely will not run out of fuel. They'll just get very, very expensive. These policies that the White House could impose could create a situation of outright scarcity and shortages in North America in a way that we wouldn't be able to pay to get around them because this whole point, sole purpose is to avoid that pump price spike. But in doing so, you would end

• 35:18Speaker 03

  up creating outright shortages instead.

• 35:21Joe Weisenthal?

  Rory Johnston, it's been too long. I was gonna say, we should chat more often, but you know, I don't want to chat again too soon because that would be a very bad sign. But it's very possible that we might be calling on you again. But thank you so much for coming on Nodlos. That was great.

• 35:36Speaker 03

  Thanks for having me, guys. Always a pleasure.

• 35:50Joe Weisenthal?

  Tracy, I really, I really like talking to Rory. I thought that was great. I think one of the interesting dynamics which I hadn't fully appreciated is that spread between the products and the price of crude. I mean, that jet fuel, I didn't totally understand why the jet fuel market or, you know, had blown out quite so crazy, but it makes intuitive sense that when there is such concern about the capacity at all to get the input, that they have to already just sort of start slowing down their pace.

• 36:20Tracy Alloway?

  Let me just say, I don't like it. I don't like talking to Rory about how the hypothetical doom scenarios that every oil analyst has been thinking about for decades and decades are now coming to pass and turning into actual reality. That's not very fun. But if we're going to talk to one person about what's happening right now, I think Rory is a very good person to talk to, someone who is not naturally doomer-ish in his thinking, but is nevertheless quite concerned about the current state of affairs.

• 36:52Joe Weisenthal?

  I think the risks from a sort of global stability perspective are very bad when you start thinking about, okay, here is this war that the US and Israel launched, and then the ramifications could be that a lot of the world's poorer countries just get completely shut off or have to deal with like crippling oil austerity. The fallout from that, again, Cetac had the specific market fallout and how long it would take to get the oil market back to normal. The sort of broader fallout from that dynamic specifically, that everyone's oil prices go up massively or get cut off, strike me as a very disturbing potential.

• 37:34Tracy Alloway?

  Well, the other thing that's rather disturbing is this idea of Russia as the new swing producer, right? And, you know, Russia, we all know, has strategic goals. You can imagine a scenario where it becomes very strategic and political in its decisions of who gets oil where. So lots to think about.

• 37:53Joe Weisenthal?

  Lots to think about, yeah, because you, especially if Europe starts to soften a little bit on Russian energy. I don't know, all kinds of weird dominos that I think are going to be knocked over because of this, beyond just the extraordinary price surge.

• 38:09Tracy Alloway?

  And meanwhile, lots and lots of episodes that we need to record. So. Not just oil. We also want to talk about fertilizer.

• 38:16Joe Weisenthal?

  Yes.

• 38:17Tracy Alloway?

  And given the news from today, it looks like we're going to have to do a Jones Act episode as well.

• 38:21Joe Weisenthal?

  Jones Act, SPR, we have a lot to come.

• 38:24Tracy Alloway?

  It's all coming. All right. Shall we leave it there for now?

• 38:26Joe Weisenthal?

  Let's leave it there.

• 38:27Tracy Alloway?

  This has been another episode of the Odd Lots Podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.

• 38:32Joe Weisenthal?

  And I'm Joe Weisenthal. You can follow me at the stalwart. Follow our guest Rory Johnston. He's at Rory underscore Johnston. Follow our producers, Carmen Rodriguez at Carmen Armin, Dashal Bennett at Dashbot, and Kale Brooks at Kale Brooks. And for more Odd Lots content, go to Bloomberg.com/oddlots for the daily newsletter and all of our episodes. And you can chat about all these topics 24/7 in our Discord, discord.gg/oddlots.

• 38:58Tracy Alloway?

  And if you enjoy Odd Lots, if you like it when we churn out these emergency episodes, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad-free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.

• 39:49Tracy Alloway?

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