The Last Ship Out of Hormuz: Why the REAL Supply Shock Is About to Hit | Rory Johnston

24:38So what you saw was, I remember the cliche kind of anecdote, I'm going to call this anecdata in the context, is that for the longest time, finance MBAs were the kind of, that was the focus of business schools, was kind of finance and optimization and efficiency. And then basically through COVID, you had this massive pivot towards operations and supply chains. And all of a sudden, those folks are much more interested in having more robust supply chains, redundancy in the system, heavy inventory stocks at different points of the supply chain so you can have failures and the entire system doesn't collapse.

25:12I think we're going to see the same thing coming out of this, that for a long time, there had been a push to reduce the size of strategic petroleum reserves, particularly across advanced countries, that oil markets have been so stable. The US shale revolution made prices cheap forever. And the 1970s felt like a really, really long time away. And now I think we're kind of punctuated this reminder why energy security of supply was a thing we always used to focus on. And yeah, I think that's going to mean more bolstered inventories, more strategic stocks, which means coming out of this, there will be a period of boosted excess demand, given that we're going to need to rebuild all these supplies, even just to refill the 400 million barrels of the SPR that's been released.

25:55On the other side, we're going to need to refill that. So that's going to manifest as kind of stock building and strategic demand on the other side of this crisis.

26:03Demetri Kofinas:So also, the 1970s oil shocks, the 73 and 79 oil shocks led to, among, other things, increased investment in offshore drilling in the North Sea, in the UK and Norway. That would be an example of a lasting change, a structural change as a result of the crisis. How much have you studied that period and how useful do you think it is as a guidepost for some of the effects that we could see as a result of the crisis in the Gulf? So what's interesting about that period is, yeah, so the big explosion of non-OPEC supply coming out of the 70s, like the shale of the day was the North Sea. And what's interesting about that is that, again, you had a period of high prices led to kind of the opening of a new production province in the North Sea, both Norway and the UK.

26:52And as that source of supply grew, and again, coming out of the 70s, we had lackluster and often negative demand growth. So balances got really squishy and soft very quickly coming out of that crisis. And we went through a soft price period. And what happened was in an attempt to basically offset that and keep prices higher, you saw at the time Saudi Arabia unilaterally cutting back production in order to kind of balance. It was essentially at the time that was, you know, you had OPEC, yes, but Saudi was like, okay, you guys are kind of a political mess. I'm just going to keep cutting back unilaterally until I think it was the summer of 1985.

27:31The Saudi king basically had it, like, you know, lost it. And he was like, why is Saudi Arabia producing less oil than the British portion alone of the North Sea? And basically, it was like, open the taps, flood the market. And that's how you got the massive price shock and the price decline of 1986 through basically the next decade until, you know, next half decade until the Gulf War. That one, you immediately led to the other. So I think the question right now is, are we going to see something similar? Are we going to see the emergence of a new kind of a novel production province? I think the answer is, at least at this stage of the crisis, likely no.

28:14The most obvious place that we would see an acceleration of production, it doesn't need to be new because we still have the US shale patch, right? There's a lot of price sensitivity there. I think even though it was rolling over and I expected US shale production to actually decline in annual terms this year. I think that's probably going to be wrong now. But prior, because when prices were in the kind of like 60s, yeah, it looked like shale was tapping out at that price level. But again, the important thing is at that price level, a lot of people treat it as a geologic fate factor. And that's not true.

28:47It's a economic reality. So at$100 crude, yeah, the shale patch is going to print barrels. But the issue right now is that they need to see that for longer, because much like the rest of the market that's only pricing this into the immediate front of the curve and saying, it's an absolute chaotic crisis in spot markets. But don't worry, Trump's going to figure this out. And we're going to be back to normal in a month or two. That same kind of belief is preventing shale from more meaningfully accelerating right now. But I think that give us another month or two of these prices. And yeah, even your kind of most tight-pocketed shale co is going to be drill, drill, drill, baby drill again very soon.

29:33Demetri Kofinas:That's also an important distinction between the 70s and today, which is that in the 70s, the capital went into offshore drilling, which has a longer investment cycle and lead time between when the capital is allocated and when you can begin to generate profits from the production of oil. The investment cycle in shale is much shorter. So you can ramp production much faster. What about investments in drilling off the coast of Guyana? Could we see more interest there? So that's actually something that we could see. Again, if we end up in a world, and again, we'll talk through scenarios in a little bit.

30:04But if we end up in a world of$150 crude and a go-forward level price, then yeah, every non-OPEC, every non-Gulf oil source is going to see supercharged investment activity. That includes Guyana, that includes US, Canada, and Brazil. And I think those are the four non-OPEC producers that you continually see cited as the kind of major source of non-OPEC supply growth. If you want to add a fifth, Argentina and the Vaca Muerta, the dead cow resource there. And what you notice, they're all in the Americas. This is fortress Americas as a non-OPEC kind of offset to supply. And that, I think, is going to be a trend that was already going to define the next kind of quarter century of the oil market.

30:47And if this remains in a place of constrained Gulf production, which means constrained OPEC production, that's going to supercharge all those non-OPEC supply bases. But again, it's going to take time. And I think in a world where the straight remains closed, even the combined effect of every non-OPEC producer on planet Earth is not going to be able to fill that fast enough, even with U.S. shale, which, as you noted, has a much faster cycle of investment to production. Offshore, we could be talking decade or more from kind of first dollar spent to first barrel out. In shale, it's probably more like six to nine months, depending on, I would say we could get it as fast as six months or maybe even a bit faster, given the intensity of the crisis.

31:29But in general, we're talking six to nine months, which again, in oil market terms is like lightning speed. But in the current crisis, where we're losing right now more than 10 million barrels a day of supply from the system, it's not nearly fast enough.

31:43Demetri Kofinas:Yeah. And it's also further evidence of how different the fate is for the US versus some of these other countries. We don't have the same sense of urgency. It does impact the global economy, obviously, but the situation for US consumers is just vastly different. Yeah. So actually just on that point, so I think that absolutely is informing the politics here. And I think that the White House And I think some US politicians that are leaning on this US energy dominance are getting part of this right, but they don't appreciate the fact that that doesn't mean that US consumers are going to be spared from five,$6 average gallon prices across the United States at the pump.

32:20That's the direction we're going with or without the fact that the United States is a massive energy superpower now. And you mentioned I'm also the host of the Oil Ground Up podcast, and I had Gregory Brew, a senior analyst at Eurasia on yesterday, actually talking about how this is essentially what, you know, with Trump's true social post about, you know, go get your own oil. You know, the U.S. doesn't need Hormuz anymore. This reality, this change in the global energy landscape has effectively ceded the ground and prompted Trump to more or less, you know, kill the Carter Doctrine and the U.S.

32:54defense of the Middle East and kind of maintenance of free flow of oil out of the Gulf. That is a massive change. And I think that even if Trump is wrong, And I do believe he's wrong about the United States not needing Hormuz. Clearly, the fact that he believes it is changing policy very quickly. And I think that's going to have consequences for everyone. Yeah.

33:14Demetri Kofinas:You've had some really great episodes on there recently. I mean, the most recent one is the one on whether or not the Carter doctrine is over. The one before that was about whether or not Trump has any off ramps for the Gulf War. So you've been really crushing it, man, on the topic. Thank you. Great stuff. So let's bring it back to the region and let's bring it back to geopolitics here. The Houthis have begun limited attacks on Israel, which has opened a new front in the war, but they haven't yet attacked vessels in the Red Sea, at least as far as what I've seen at the time of this recording, and as I said, we're recording this on April 1st, what happens if transit through the Bab el-Mandeb Strait connecting the Red Sea to the Gulf of Aden also becomes constricted?

33:53Yeah, it's a big problem. It would be a very big problem. So just to kind of, again, context here. So the main offset, the main rerouting offset of the blocked Strait of Hormuz is the Saudi East-West Pipeline, which goes from the Gulf side of Saudi Arabia all the way to the industrial port of Yanbu in the Red Sea. Now, that is, again, our most important rerouting offset from the Hormuz closure. But as you note, that puts it out right next door to the Houthis, which very recently had been the main focus of the global oil market given their forced closure, the Bab-Elmendeb Strait, and the broader kind of traffic through the Red Sea.

34:33Now, there's two things to keep in mind here. So the first thing is just logistical ease. Right now, you basically have seen a complete rerouting of the vast majority of normal Saudi transit, largely Asia, has now come up through the Bab El-Mendeb to Yanbu, turned around and gone back. A very straight shot and actually not that dissimilar from the normal route coming from the Gulf. But if that Bel Bel Bel Bel Strait was blocked, then they would have to basically get forced north through the Suez, all the way around the Med, all the way around the Horn of Africa, and then over. It basically more than doubles the transit time to Asia, which given our, I mentioned that this is a largely a crisis of lost time and across time and space, that is a major issue because it basically just means you lose more supply in the short term.

35:24Demetri Kofinas:And of course, it increased the price of the supply. It increases the price of supply as well. And obviously the risk, the Houthis kind of do more and more and more. I'll also note that there likely isn't enough capacity through the Suez to completely reroute the entirety of those Yondu flows. Because one, you already have traffic, normal traffic going through the Suez. It's obviously, that's why we were talking about the Houthis originally. That is normally a very important source and transit point for oil. Shit, you can't get a VLCC, the largest tankers that are doing the majority of this journey to Asia.

35:55You can't get them through the Suez in the first place is the entire point of why you have Suez Max tankers. And Suez Max tankers can't even transit the Suez full. They have to offload some of their oil into the Sumed pipeline, which itself has a capacity of just more than 4 million barrels a day. All that together means that if the Houthis did start causing an issue and did effectively block the Babin Mendeb, you would likely see effective Saudi supply to the market materially reduced in the short term. Now, both via logistical rerouting and the kind of extra time it needs, but also by the fact you just likely can't see that much, that full flow rerouted through Suez.

36:35There's two things here, though. I think we have seen the Houthis attack Israel, and you have seen them kind of lean into the fight. But you haven't yet seen them target shipping, and you haven't yet seen them confirmed target Yanbu or the port or the infrastructure around that kind of termination point of the East-West pipeline. There have been attacks. I'm losing track of time now, but I just want to say it was a week and a half ago. You saw attacks on the refinery and the port at Yombo, but no one confirmed who the attack was by. The loose, you know, word was that it was Iran, but that's a very far distance for Iran to attack.

37:14And that's not impossible, but it makes more sense for the attack to have been from the Houthis. But we haven't seen subsequent attacks. So that I think is a big question. And that's going to be a lingering concern for the oil market. The fact is that the Houthis, and again, go listen to, you know, people should go listen to that conversation with Greg Brew, because he actually talked a lot about this as well. And there's way more about the Iranian politics and kind of Houthi connection than I do. But he made the point, I think very reasonably, that the Houthis are less of a kind of a Hezbollah-esque proxy of Iran, and more like an ally.

37:47And that Houthis themselves have other priorities as well, which is like maintaining essentially money to govern the country of Yemen. And that right now has largely increasingly been supplied by Saudi Arabia. So Saudi Arabia is essentially paying the Houthis a lot of money. And if the Houthis get who into the war and they get too problematic and they blow up the port of Yombo or the refinery or the tankers, that would probably make Saudi Arabia very angry. Now, so in their interest, their best position in this is to prove and remind Riyadh that they can do this, which might mean an attack. It might mean something else.

38:27But I think that that would be more a means of extracting yet additional kind of financial largesse from the Saudis rather than kind of fully blockading the Babylonian dead. Although, again, if this gets to kind of existential end of Tehran kind of territory and there is the kind of longer lived cultural alliance between the Houthis and the Iranians, then I think you could see something more aggressive. But I think in the interim, it doesn't seem like they are that interested in completely blockading the strait yet.

38:58Demetri Kofinas:So shout out to Eamon Dean and Thomas Small, the hosts of the Conflicted podcast. They put together a phenomenal miniseries on the Yemeni civil war. some years ago, which included some discussion about the Houthis, among many other series that they produce. So definitely check them out. All right, let's talk Trump. Tonight's national address. First of all, are you watching? Yes. Unfortunately, I will definitely be watching. What does your family think when you have to make private time to watch Trump provide color commentary on national television? Well, if my three kids age six, four, and two are not asleep by 9 PM, I'm already having a really, really bad night.

39:38So hopefully they'll be asleep. And my wife helps run the business with me. So she's going to be editing whatever piece I ended up writing about the address anyways. So it's actually helpful for her to be great. So you don't have to do this alone. You don't have to do this alone. Fantastic. Because for me, unfortunately, these are lonely nights. So what do you think he's going to say? Okay, so let's talk scenarios now. So I just tweeted earlier because I again, I knew I was coming on the pod. And I want to put my like a line in the sand. Okay, this is what I think the rough probabilities are. And they're going to be a weaselly kind of equal bucketing of three different things with my most likely one at the top.

40:08I still think the most likely scenario here is what I call the unilateral Trump talk, which is a lot of people say Trump can't talk. This is a war, not a tariff, not a trade policy. You know, there are other people in this conflict have a say. I'm like, sure, but none of their says matter as much as Trump. And none of them being Israel and Iran are as influenceable by external pressures by the market or by politics. it's only Trump that really is the one that has the latitude to kind of say, this is over. And people are like, oh, well, no, he's constrained by alliances with the Gulf, or he's constrained by the Carter Doctrine, or he's constrained by whatever.

40:48I'm like, no, Trump is an unconstrained human being, not constrained by really any norms or precedent. So I don't buy it. The way I see this happening is essentially the price. I don't think it happens yet. I think that the price still goes higher. And I think one of the potential things is like we get a formalization tonight of, you know, there have been reports recently that Trump sees this lasting two to three weeks. Maybe we just get a formalization of that. But I think what that would look like is essentially Trump says, we're done. He begins pulling back the Navy unilaterally. You know, we saw the Wall Street Journal kind of story two nights ago now that talked about how Trump is increasingly open to ending the Iran war without the straight being open, which has a lot of people scratching their heads.

41:32But again, I think dovetails with this thesis, which is kind of like Trump, at a core, my overriding belief from the beginning of this is that Trump never meant to start an Iran war like this. He never meant to get this deep. He saw this as something as the latest iteration of the US engagement in the 12-day war last year, where they basically bombed three nuclear facilities on a Saturday. And by the Monday, he had basically declared a ceasefire. And prices, I think, fell$15 a barrel on that day.

42:00Demetri Kofinas:And remember, actually, he hedged his bets in public when the war began, not claiming credit for it, expressing some frustration with Israel, and then subsequently saying, I want credit for this. So he got very impressed and was very happy with the outcomes. Right. And I think he's been back and forth, right? So I think that he has the capacity to declare victory pretty easily. It's kind of one of his superpowers, right? That he can kind of say, well and again he said they've won pretty well every other day since the war had started so clearly he has the the rhetoric to declare this over but yeah so i think that's how this essentially goes down and then basically he pulls back ron maintains some kind of quasi control over the strait maybe with some kind of tolling arrangements maybe allows 50 60 percent of pre-war flow to go keeps a tight hold there's a kind of a weird scenario that you can kind of see this going forward.

42:52But I want to stress that even in the scenario, this is not a healthy scenario for the market. This is a deeply, deeply risky scenario for the market. It's inherently unstable and politically untenable for the region. And it basically just sows the seeds of our next very, very predictable kind of blow up of this crisis. I think, so that's 40 % I put on that kind of unilateral chart.

43:14Demetri Kofinas:Before you go to the next scenario, what is the next predictable blow of this crisis. So what comes out of Trump taco-ing? What does that look like? So I think you'd have a period of months, maybe a year, where you have some kind of forced payment or kind of a tribute to Iran to get through the strait. The Gulf countries are deeply unsatisfied and existentially unhappy about this for obvious reasons. In the best-case scenario, they wouldn't want this in a normal world. And they have just spent the last month getting pummeled by Iranian missiles and drones. So this is like a deeply unpopular position for them.

43:50But at the end of the day, if the US has withdrawn, they're kind of stuck with the bag because if they either fight Iran on their own, which is untenable, or they pay the toll and they resume the flow of their main commodity export, which is oil, gas, fertilizers, natural gas, everything else. And I think that the number that had been bouncing around was the Iranians were charging$2 million for a transit of a vessel, which is a lot of money. But if you're looking at a VLCC tanker, which carries 2 million barrels of crude oil, that's a buck a barrel. That's a lot for transit, but it's relatively limited in the scheme of the impacts we've already seen to the market.

44:32A dollar a barrel is a lot less than$50 a barrel, which is the increase we've seen since the war has started. So I think that kind of scenario is something we could see, but then to the instability of it or instability of it, I think you end up in a scenario where, you know, Iran doesn't stop its missile program. You know, now it probably keeps tinkering with its nuclear program. You know, this, we ended back in a situation we were before, which is essentially like a clock. And maybe Israel decides to go mow the lawn or mow the grass again, you know, taking out, you know, Iranian facilities. And then Iran closes the strait again for a couple of weeks.

45:04So like we could end up in this kind of recurring scenario that the pre-war scenario, everyone was worried about the unsustainability of Iran's nuclear program, etc. But we had been in that state for a decade. This scenario where Iran has this kind of quasi-control of the trade is much, much less sustainable. And I think that it can only go on for so long before something breaks again. So I think that's the scenario that I put roughly a 40 % chance on. I guess we should talk about price impacts. I think if that scenario happened, given the market sensitivity right now to Trump's comments. I think we would sell off pretty sharply on that.

45:42But I do not think that that scenario is bearish relative to current pricing. And I think that after such a price sell-off on sentiment, on whatever, I think the market would then grind back higher again and probably end higher than the point of the sell-off because that cumulative effect of the physical loss is still happening. And the market will eventually have to recognize that.

46:04Demetri Kofinas:But the curve would become less backward dated as a result of that, presumably, right? Exactly. Because futures markets would begin to price in closer to spot. Yeah. And I think that in that scenario, again, that's still bullish relative to current spot prices, but I think is bearish relative to the next scenario we'll talk about, which is boots on the ground, chaos in the Gulf, and potentially like a full-blown global meltdown. And I think that's, I put that at kind of a 30 % chance right now, which is a disconcertingly high probability of such an event happening. But I think a lot of people will say to me like, Rory, how can you think there's a talk coming?

46:39You've said this for weeks and you've been wrong. True. And they're like, don't you see the US military assets building up the region? Don't you see the Marines headed for theater? Don't you see all these troops coming in? Clearly he's going for boots on the ground. And very frankly, it's not a bad argument. I think that what we have seen is time and time again, and even before the war started, Trump was basically saying, we're negotiating. We're going to figure something out all the while building up military assets for what obviously turned into a very large military engagement. That path, if it continues, leads us to a scenario of boots on the ground, likely trying to go after the highly enriched uranium and secure that directly or going after Karg Island or trying to kind of secure the ground area and the mountains around the straits to kind of reduce the propensity and the ability of Ron to attack shipping.

47:30All of that, I think, ends us in a scenario where the strait remains closed in its current state for months more at a minimum and potentially even longer, as well as putting us into a position where Iran is much more likely to hit other upstream assets. Because I think while this situation we're in with the strait closed is extraordinarily serious and deeply unsustainable, it is not as bad as things can get. You can still open the strait. The majority of upstream production assets in the Gulf are still operational. They're just shut in. But one thing we have seen is that in this, you know, Iran's very willing to go in these tit for tat exchanges.

48:13And following two weeks ago or so when Israel attacked Iran's South Pars gas field, they immediately responded by detonating and basically exploding the Rosloff and natural gas facility in Qatar, which as Reuters later reported, the CEO of Qatar Energy said that that was a 17 % reduction in Qatar's LNG export capacity that could last up to five years. If we started seeing similar types of kinetic attacks on Abcake, like we saw in 2019, or the East West pipeline, or any of the Iraqi, Kuwaiti, Amradi, and Saudi fields, this turns from something that can be unwound relatively quickly in a matter of months to something that will take years to unwind.

48:55And that, I think, is the ultimate chaos kind of global meltdown scenario. In my opinion, that's the scenario we end up in$200 plus crude, even more expensive products, and a global recession.

49:07Demetri Kofinas:And a rampant production in the United States. And a rampant production in the United States. In that scenario, I think the United States would probably end up growing at near all-time high levels. I think the all-time high was 2018 at more than 2 million barrels a day of liquids growth. I could see us getting back one and a half, two again at those prices. But even then, just thinking through the math, that's the fastest US has ever grown. And again, the fastest that basically any country has ever grown in history in terms of the pace of growth. And even then, that would take five years to fill in 10 million barrels a day of supply loss.

49:40So I think it's just in terms of the scale of what we're talking about, that's why I think you're going to need to see those very, very high prices to force demand to be destroyed and contract in order to balance that equation. Otherwise, we basically empty our inventories globally. And what have you reserved the other 30 % for? The other 30 % is reserved for the cockamamie, insane kind of collection of every other scenario I've seen very confidently proclaimed at me, like Trump co-owns the strait with Iran and starts taking a cut of the tolls and you see all manner of other things. And I think, I mean, just go read through my replies on Twitter and you see a fairly colorful rainbow of insane geopolitical scenarios that I just don't see as likely.

50:24But again, this entire episode is unlikely. So we are in the realm of the improbable at the very least.

50:31Demetri Kofinas:Well, I'm going to be watching with incredible suspense this evening, Rory, and I'll be texting you furiously once we get some kind of news so I can get your take on it. Thank you so much for coming back on the podcast. It was really wonderful to see you again. Thanks so much for having me, Dimitri. I wish you the best of luck with Commodity Context and also with your podcast, man. It just looks fantastic. You're crushing it. Thanks so much. You're very, very generous. All right. Take care, Rory. If you want to listen in on the rest of today's conversation, head over to hiddenforces.io slash subscribe and join our premium feed.

51:02Demetri Kofinas:If you want to join in on the conversation and become a member of the Hidden Forces Genius Community, You can also do that through our subscriber page. Today's episode was produced by me and edited by Stylianos Nicolaou. For more episodes, you can check out our website at hiddenforces.io. You can follow me on Twitter at Kofinas, and you can email me at info at hiddenforces.io. As always, thanks for listening. We'll see you next time.